But, like everything else, decentralization has its drawbacks. For example, traditional companies often start with loose structures, but become centralized over time to foster efficient planning and implementation, focused product vision, and well-defined organizational structures. Decentralization requires removing centralized control while ensuring organizations don't suffer from problems centralization was designed to correct.

For crypto-native businesses, starting out decentralized can be very difficult—if not impossible. This is where progressive decentralization—the idea of decentralizing over time instead of doing it immediately—can help. In this guide, I discuss progressive decentralization, explain what it means for web3 projects, and highlight how different projects across web3 are embracing this concept.

The meaning of progressive decentralization

Progressive decentralization is the process of relinquishing centralized control of a particular resource, system, or organization over time. An example of progressive decentralization is gradually revoking privileged permissions over a protocol and transferring decision-making powers to a distributed network comprising members of the protocol’s community (e.g., users and developers).

Progressive decentralization favors approaching decentralization in phases instead of attempting to achieve sufficient decentralization from the onset. This is important because decentralization, if handled improperly, can create more problems than it solves. For example, without a central actor coordinating economic interactions in a decentralized protocol, users may be forced to pay the price of anarchy.

Why progressive decentralization is crucial for web3 projects

Today, early-stage companies adopt the lean startup methodology—a business model that emphasizes rapid iteration, innovation, and experimentation (instead of complex planning) on the road to product-market fit. Crypto products are no different and must iterate quickly based on user feedback and performance analyses. As a result, many web3 projects tend to rely on small, centralized teams in the early phases to drive efforts at achieving product-market fit and creating sustainable business models.

But just because a web3 project starts out centralized doesn’t mean it must stay that way forever. Progressive decentralization ensures product teams are well-equipped to drive business goals early on while creating processes and infrastructure to support decentralization in the future. This allows protocols—having achieved maturity—to transition into decentralized entities owned and operated by users (with minimal reliance on the founding team to coordinate activities).

How does progressive decentralization work?

Progressive decentralization can take many forms depending on an organization’s objectives. But first, it helps to understand the benefits of decentralization before looking into strategies for achieving it. Web3 projects can benefit from sufficient decentralization in the following ways:

1. Resilience and robustness: Decentralized protocols have historically been harder to disrupt and shut down—whether by nation-states or motivated groups and individuals. That’s because such protocols are designed to operate without single points of failure or choke points that malicious actors can exploit.

2. Community ownership and participation: Putting a protocol’s community in charge of operations typically incentivizes users to play active roles in the protocol’s development and future growth. Moreover, access to diverse perspectives and voices means projects can make more informed decisions that benefit the majority of users—not a narrow subset of stakeholders.

3. Value distribution: Decentralized networks redistribute more economic value to participants than their centralized counterparts. For example, a decentralized protocol might financially reward external contributors (e.g., developers), or distribute a share of protocol fees to users.

By sharing value with the community, decentralized protocols create a virtuous cycle of sorts: user commitment and contributor participation increases, directly benefiting the protocol’s growth, which increases the economic value redistributed to community participants. In short, decentralized protocols play a positive-sum game that benefits all parties instead of a zero-sum game that solely benefits the business.

4. Accountable leadership: In a typical organization, information asymmetries (among other factors) prevent the wider community from holding leaders to account for making certain decisions. Conversely, decentralization increases transparency and accountability, ensuring the community members can hold protocol teams accountable for their actions.

Another benefit of decentralized governance and decision-making is that users are aware of the rationale behind decisions affecting the protocol. This empowers users to make informed decisions about whether to withdraw or lend their support for certain proposals (depending on the extent to which these decisions align with their interests).

A framework for progressive decentralization

Having explained why decentralization matters, we can now evaluate the different ways in which web3 projects can progressively decentralize:

Infrastructure

When building blockchain applications, some elements of the development stack (e.g., off-chain storage or node infrastructure) may be centralized. Centralized infrastructure can provide efficiency, customizability, ease of use, and cost-effectiveness—things early-stage companies need to build viable products.

But, as a project matures, it becomes necessary to start thinking about decentralizing critical infrastructure. For starters, this can improve fault tolerance, reduce the risk of censorship, and increase reliability for users. Using decentralized infrastructure also prevents platform lock-in and provides more flexibility for development teams when choosing what services to use.

Below are some hypothetical examples of how a web3 project could gradually decentralize its infrastructure:

• A decentralized social networking protocol might move from using centralized databases (e.g., Amazon S3) to using distributed, peer-to-peer storage platforms like Arweave, Filecoin, IPFS, and Ceramic for data storage

• A DeFi protocol may use a centralized node provider for blockchain access and later shift to a decentralized infrastructure network comprising different blockchain node providers

That said, progressive decentralization doesn’t apply to base-layer blockchains, like Ethereum and Bitcoin, whose value lies in being sufficiently decentralized from genesis. In comparison, Layer 2 (L2) blockchains (e.g., rollups) may adopt a progressive decentralization model; an example is a centralized sequencer for low-latency execution of transactions before shifting to decentralized sequencing to mitigate censorship and avoid downtime owing to failure of a centralized sequencer node.

Governance and decision-making

As explained, building a web3 product demands quick iteration and fast implementation of design decisions in the early stages. Thus it is non-ideal to have a large group of people making decisions about a product at this time (aka “design by committee”). Rather, project teams should be lean and comprise individuals with the experience, expertise, and drive to steer product development forward.

However, once a project achieves some notion of product-market fit (reflected in daily protocol revenue, TVL metrics, etc.), it may start transitioning into community-led governance. Instead of core teams deciding behind closed doors, the decision-making process is public and open to all members of the community. Governance decisions may cover technical aspects of a protocol (e.g., upgrades, freezes/shutdowns, and parameter/variable settings) and non-technical matters (e.g., treasury allocations).

Scaling decentralized governance and crowdsourced decision-making can be difficult, but not if teams channel efforts toward making it work. This may mean documenting internal processes to give context for governance decisions, for example, or using tools that enable members to signal preferences and reach consensus on proposals securely and transparently.

Establishing decentralized governance requires locking away special powers conferred on core team members at the beginning. Community ownership is hardly useful if a powerful minority (e.g., project founders) can override the majority’s wishes.

Furthermore, it is important to give vocal minorities the freedom to exit the protocol if they disagree with a particular decision. This may involve imposing delays on the implementation of governance decisions, which protects users against being forced to accept unfavorable proposals.

A high-level of DeFi protocol Compound’s decentralized governance mechanism. (Source)

Finances

Web3 promotes the redistribution of the value generated by protocols to those responsible for creating that value (i.e., users and contributors). Therefore, projects need to develop mechanisms that align economic interests of users with the protocol. An example might be airdropping tokens to community members and letting token-holders earn a cut from protocol fees.

Beyond value distribution, protocols must also enshrine processes for the community to (transparently) decide on financial issues, such as allocating funds to protocol development efforts, rewarding core team members and external contributors, etc. Setting up a protocol treasury managed by a multisig wallet (composed of signers elected by the community) is a popular approach among DAOs and DeFi projects. This arrangement promotes auditability and prevents financial mismanagement that can occur in the absence of centralized governance.

Human resources

For crypto-native businesses, progressive decentralization may involve transitioning from being “lean startups” to “open-source organizations”. This means the project no longer relies exclusively on the efforts of the core team but instead taps into the wider community for individuals to steward technical and non-technical roles.

For this part of progressive decentralization to work, teams need to lay the groundwork early into the project. Core team members can set up roles and internal processes in a way that makes it possible for others to take over responsibilities, for example. Building and collaborating openly can also reduce information asymmetry and reduce the barrier to entry for new contributors.

This phase of progressive decentralization also requires investing in best practices for running open-source projects. Creating good documentation outlining a project’s objectives, contribution guidelines, and code of conduct (among others) is usually a good place to start. Developing mechanisms rewarding the efforts of contributors (e.g., using a reputation system) is also important—incentives can encourage participation where appeals to altruism fall short.
Case studies of progressive decentralization in web3

Case studies of progressive decentralization in web3

Infura

Infura is a great example of how a web3 product with startup roots can progressively decentralize. Initially created as a software-as-a-service (SaaS) platform to provide users and developers with access to blockchain data, Infura is building a decentralized infrastructure network to create a robust and resilient RPC layer for Web3.

“Infura’s Path to Decentralization” provides a high-level overview of Infura’s decentralized infrastructure network. Here, Infura’s current service will exist in parallel with selected node infrastructure providers (“Node Operators”)—allowing developers to route RPC calls through multiple points (via “Ingress Operators”) instead of relying on a centralized provider. Not only does this reduce the risk of downtime for dapps, but it also protects end-users against the risk of censorship and discrimination—ideals tightly woven into the fabric of web3.

Proposed architecture of Infura’s Decentralized Infrastructure Network (DIN). (source)

Astute readers will notice that Infura’s approach to decentralization resembles infrastructural decentralization, which I discussed earlier. Elements of decentralized governance also exist in the plan—for instance, the task of monitoring and evaluating node operators is handled by a decentralized body of “Watchers” equipped with the power to penalize operators that experience excessive downtime.

Uniswap

One of the first DeFi projects to achieve product-market fit, Uniswap transitioned to community-led governance after announcing the release of UNI, a governance token endowing holders (including members of the community) to propose and ratify proposals affecting the protocol’s future. And while Uniswap’s core team is still involved with the project, development of future iterations of the protocol have seen greater involvement from members of the community—see this blog post on community contributions to Uniswap V4 for an example.

Despite becoming a community-owned product, Uniswap has remained profitable to date and recently surpassed trading volumes of centralized rival, Coinbase. This demonstrates the viability (and importance) of building sustainable applications without sacrificing web3’s ethos of open-source development and permissionless innovation.

Optimism and Arbitrum

Optimism and Arbitrum are the biggest Ethereum rollups today (by economic activity). Besides sharing similar technology and infrastructure, both projects have displayed commitment to adopting progressive decentralization in various forms:

• Arbitrum airdropped ARB tokens to community members and contributors earlier this year and formed the Arbitrum DAO to coordinate future protocol development efforts, manage treasury funding and allocation, and provide an open space for discussions on issues affecting the protocol.

• Optimism has taken similar steps—forming the Optimism Collective after announcing the distribution of a governance token (OP) to users, founding team members, and ecosystem contributors. Optimism’s core team has also outlined the protocol’s vision for progressively decentralizing key parts of the infrastructure stack to increase the network’s robustness and security.

Optimism’s technical decentralization roadmap. (source)

MetaMask

MetaMask (a web3 wallet) recently announced the (beta) release of the Snaps SDK, which will allow developers to build standalone apps (plugins) that users can install to customize and enrich the functionality of MetaMask’s wallet application. Snaps execute in a sandboxed environment—to prevent plugin bugs from compromising the security of assets stored in the main wallet—and can only run scripts approved by end-users. Below are some examples of Snaps from the official Snaps directory:

The “progressive” in progressive decentralization for MetaMask here means certain aspects of the decentralization process will see some centralized control initially. To illustrate, users are currently limited to installing Snaps that have been vetted for security by MetaMask’s in-house team; but the long-term plan—as explained in the announcement post—is to lift this restriction and pave way from permissionless innovation, where anyone can create a Snap and users can install it without relying on MetaMask's approval.

Some would argue decentralization at this layer of web3 isn’t necessary (“you can’t just decentralize everything!”) or possible (“how do you decentralize a primarily user-facing product like a wallet?”). However, as founder, Dan Finlay, discusses in a post, it is both feasible to decentralize a web3 product like MetaMask—it just takes work—and necessary, especially if we want to avoid reintroducing web2’s walled gardens and lack of user input in product development and application UX.

This form of decentralization also exemplifies the framing of progressive decentralization in crypto-native applications as positive-sum game:

1. MetaMask’s product team can’t ship every feature—even ones with significant demand from users—due to constraints like limited manpower and the need to prioritize safety (an important consideration, given that wallets are responsible for holding valuable assets like tokens and NFTs, and software bugs can cause non-trivial losses); if MetaMask operated as a pure, Big Tech-esque (closed-source) product, the only viable option would be to limit users to the functionality the team is able to provide—but progressive decentralization means it can do better to deliver on web3’s promise of decentralizing digital infrastructure and encouraging composable and open innovation.

1. Using the MetaMask Snaps SDK, any developer can build new features on top of the MetaMask wallet application, and users can install those features to customize the wallet experience. For example, transaction insight Snaps protect against malicious attempts to drain wallets by spoofing legitimate websites, and interoperability Snaps allow users to connect MetaMask with non-EVM (Ethereum Virtual Machine) blockchains).

2. With new Snaps-powered functionalities, MetaMask is able to keep users happy without placing additional burdens on its product team to ship more features at a rapid place (which has also has the nice property of reducing the likelihood of software bugs). In return, third-party developers behind various Snaps get access to MetaMask’s impressive user base (100M users and counting), without having to build a rival product from scratch.

3. Reducing user churn (and adding more users) means more opportunities to sustain or increase MetaMask's usage, which may improve the product's overall bottom-line. With (potentially) increased revenue, MetaMask can improve its core product and even fund other proposals to build new Snaps (e.g., through MetaMask Grants DAO) that contribute positively to the experience of using MetaMask.

In other words, it’s a win-win for everyone involved.

Conclusion

Progressive decentralization is still poorly understood and there’s hardly a one-size-fits-all solution for achieving it; moreover, decentralization—especially when it touches mission-critical components of a protocol’s architecture—can take time to implement safely. Ultimately, web3 projects must approach decentralization in unique ways whilst making sure it doesn’t stifle growth and innovation, or introduce undesirable second-order effects.

This article has provided a useful “minimum viable framework” project leads in web3 can use to guide progressive decentralization efforts. Still, those in search of more comprehensive analyses may want to read Progressive Decentralization: A Playbook for Building Crypto Applications, Sufficient Decentralization: A Playbook For Web3 Builders and Lawyers, and Whole Crypto Catalog: Progressive Decentralization. These are excellent resources for crypto founders, developers, and enterprises thinking about decentralization and provide a more holistic framework for making specific decisions about organizational components.

Cover photo by Alina Grubnyak on Unsplash

Even though it improves on the Web2 Internet, Web3 needs composability to unlock value for users and foster innovation. This article outlines the principles of composability, the benefits of a composable system, and how it fits into the Web3 infrastructure.

What Does Composability Mean?

In application development, composability refers to the ability to combine existing components and reassemble them to create new products.

In a composable architecture, every component has a specific use case. Developers can then combine these components and add new functionality to build applications—without having to reinvent the wheel or build from scratch.

As explained earlier, composability was and is a feature of open-source technology. Anyone could create open-license software, which other developers can use in their products, without fear of litigation or patent infringement issues.

The early days of the Internet were built on this idea of collective access to technology. For instance, CERN famously released software for the World Wide Web.

However, Big Tech giants eroded composability to preserve company profits. Companies like Google, Facebook, and Amazon now protect software through overzealous patent protection, data protection, and deliberately engineering products using incompatible tech stacks.

Moreover, Web2 companies lock users into platforms and prevent usage of rival platforms by implementing high switching costs. The result is a fragmented system, where each component cannot be combined to create greater value.

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Composability in Blockchain Technology

The explosion in decentralized technology (Web3) has triggered a new interest in software composability. As open-source technologies, blockchain applications are highly interoperable and can benefit from existing libraries to create new experiences for users.

In the context of Web3, composability is the ability of blockchain applications, like decentralized exchanges (DEXs), decentralized applications (dApps), and decentralized autonomous organizations (DAOs) to communicate and work with each other.

Specifically, composability in blockchain technology means developers can freely use and integrate code from other applications into their products. This is because smart contracts—which control application logic—are open-source and available to the public.

Composability in blockchain technology helps shorten the development cycle for decentralized applications (dApps). Previously, developers would've to develop every feature of an application from the ground up. But composability allows developers to modify code libraries from existing dApps to create new apps, reducing time spent on writing lines of code.

An area of blockchain technology that’s benefitted from composable software is decentralized finance (DeFi). For example, SushiSwap launched its decentralized exchange by copying Uniswap's codebase and adding extra features, such as a governance token and liquidity mining.

There are even more examples of composability in Web3, which I explore in the next section.

How Composability Unlocks Value in Web3

Composability is necessary for creating an interoperable system where disparate elements can connect seamlessly. Components of blockchain technology, such as dApps, DEXs, and DAOs, are composable by nature, allowing them to be reassembled, duplicated, or integrated into one another.

Blockchain composability typically occurs at either the smart contract or project level. This allows developers to combine powerful components to design new applications and unlock greater possibilities for users.

Syntactic Composability

Syntactic composability denotes the implementation of several components, such that they can be connected to form entirely new systems. Syntactic composability thrives on three critical components:

Modularity: Each component in a composable infrastructure must solve a specific problem and do it well. This allows developers to assemble modular components into one product, with various elements handling different tasks.

Autonomy: Components in a composable architecture must be able to work independently without relying on other components for functionality. It also means each element can be modified without affecting the overall structure

Discoverability: Composability allows developers to harness repositories of reusable software frameworks and libraries. But these libraries and frameworks must be "discoverable" for others to use. In other words, code must be open-source and available for unrestrained modification and usage.

Ethereum is a classic example of how syntactic composability works in blockchain technology: smart contracts function as reusable elements anyone can use. This means development teams can re-use basic contract code and concentrate on building core infrastructure for dApps.

The Ethereum.org website puts it thus:

Smart contracts are public on Ethereum and can be thought of as open APIs. You don't need to write your own smart contract to become a dapp developer, you just need to know how to interact with them. For example, you can use the existing smart contracts of Uniswap, a decentralized exchange, to handle all the token swap logic in your app – you don't need to start from scratch.

Within the Ethereum ecosystem, smart contracts are building blocks that developers can apply to build even more complex applications. The SushiSwap-Uniswap example mentioned earlier shows how different projects can use similar codebases to achieve different objectives.

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Other blockchain applications also benefit from syntactic composability. For example, a new DAO might find building a bespoke governance system costly and time-intensive. But it can simply use a library of governance tools, like Aragon Client, to bootstrap and scale a usable governance system.

Atomic Composability

"Atomicity" is a concept in blockchain technology that introduces the idea of combining multiple actions into one transaction. This transaction can be anything from a token swap between two individuals to smart contract calls.

The principle of atomicity maintains that every action in the transaction must be correct and possible for it to work. If a single part of the transaction fails, then the entire transaction fails as well.

Atomic composability—a combination of atomicity and composability—is, therefore, the idea that a single transaction can involve calls to different smart contracts. The failure of one part of the transaction causes the transaction to fail: the transaction either succeeds together or fails together.

Moreover, atomic composability is possible only if the parts involved in the transaction are hosted on a single same execution layer. It'd be impossible to conduct a complex transaction that involves using dApps running on different chains—say, Ethereum (Layer 1) and Polygon (Layer 2).

The best examples of atomic composability come from the DeFi ecosystem. Here are a few examples of atomic composability in action:

Flash Loans

For those who haven't journeyed deep into the weeds of crypto and DeFi, a flash loan may seem like a futuristic concept. However, flash loans follow a simple pattern and work because of atomic composability:

The idea of a flash loan is simple: you borrow and pay back a loan within a single transaction. Flash loans operate on atomic principles, meaning lenders will get their money back if the transaction fails. This paves the way for uncollateralized loans since borrowers cannot (theoretically) default on repayments.

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Atomic composability means a flash loan can involve different activities executed across different platforms (provided those actions generate enough tokens to repay the loan). Here's an example, taken from arbitrage trading, to explain the concept:

Say a token (MKR) is trading higher on one exchange (Uniswap) than on another exchange (Kyber). The arbitrage trader (Bob) lacks enough funds to buy MKR on Kyber and sell on Uniswap for profit, so he takes out a flash loan.

Here’s the fun part:

Bob can use the loan to buy MKR on Kyber, sell the MKR tokens on Uniswap, take out the profit, and return the initial capital to the lender. And all of these actions happen in a single transaction. If one part fails, then the entire deal falls through and the lender gets their capital.

Taking out a loan in the real world would involve a painful amount of paperwork and lots of time-wasting, hindering efficient arbitrage. Thanks to atomic composability, flash loans make it easier for arbitrage trading to benefit from higher liquidity and generate profits.

Automated Market Makers (AMMs)

Automated market makers (AMMs) are protocols that enable the trustless and automatic trading of crypto tokens. You can think of an AMM as a robotic "portfolio manager" that makes investment decisions based on an analysis of current market conditions.

Yearn is an example of a popular AMM among DeFi enthusiasts. The Yearn AMM can automatically scan different DeFi platforms and move your tokens to where you'll gain the most profit (by earning trading fees, for example).

However, Yearn can only work because of two reasons:

1. It can access data about token prices on different DeFi platforms. If each platform protected platform data, the Yearn algorithm wouldn’t be able to compare token prices.

2. Different components of the DeFi ecosystem can be combined quickly within the same transaction. For example, the Yearn trading bot can use ETH as collateral to borrow DAI stablecoins from MakerDAO, use DAI to earn CRV tokens on Curve, sell CRV for ETH, and return ETH to MakerDAO for collateral.

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Decentralized Identity and Composability

Another application of composability in Web3 is identity management. Currently, identity frameworks are hardly composable since each platform must engineer its system for collecting and managing user identities.

One of Web3's biggest improvements is the ability of users to transfer their identity across dApps. Users can store identifiers in their wallets and grant read-only access to dApp authentication systems. This means you don't have to remember long passwords or provide the same details to dozens of applications.

This contrasts with the centralized Internet, where different providers cannot share identity information. That's why you have different account information for Facebook, Twitter, LinkedIn, and more—even if the information is, more or less, the same.

Obstacles to Web3 Composability

While composability is a noble idea, implementing it can be difficult for many reasons:

Security Concerns

A big part of blockchain composability derives from the ability of smart contracts to call other contracts. This is what makes complex transactions involving different contracts possible.

However, calling external contracts isn't always the best idea. For instance, calling a malicious contract could lead to exploits, especially re-entrancy attacks.

For composability to become the standard, strengthening smart contract security is important. This makes it easier for developers to safely integrate logic from other contracts into their contracts.

Intellectual Property (IP) Protection

Up until now, blockchain technology has thrived off the ideals of open-source technology and codebases as "public goods". But there are signs this might change sooner than expected.

After the SushiSwap incident, Uniswap built a clause into the v3 release of its software to prevent unauthorized usage or forking. Although sensible, such moves may re-introduce the 'walled gardens' of Web2, where organizations prioritize self-preservation over collective growth and innovation.

If projects start to register smart contracts or prevent usage, then composability will die a slow death. As explained earlier, composability requires software to be open-source and available for usage and modification.

Inadequate Standardization

Composability in blockchain benefits from standards. For instance, Ethereum ensured interoperability by creating standards known as Ethereum Requests for Comments (ERCs) for smart contract interfaces.

The ERC-20 standard, for example, defines how a fungible token should operate. This makes sure it's compatible with other components of the Ethereum ecosystem, such as wallets, DEXs, dApps, and so on.

However, with the explosion of blockchains, it may be difficult to create standards that will ensure the composability and interoperability. It is important to agree on industry standards, lest Web3 becomes a collection of walled gardens itself.

Final Thoughts

Initially, I thought of naming this article, "What Do Orchestras And Web3 Have In Common?". Like an orchestra, Web3 benefits from having disparate but composable elements combine to create new results.

While this article has covered composability extensively, there are more applications of a composable infrastructure in Web3. With time, developers will find ways to adapt pre-existing components to fabricate new systems that provide exceptional functionality.

Whether Web3 will continue to encourage composability remains to be seen, though. Better smart contract security, greater collaboration between development teams, and higher standardization are necessary to create a truly composable Web3 ecosystem.

Cover Photo by Ryan Quintal on Unsplash

Because Web3 was a new and rapidly changing field, identifying core components of the development stack used to be difficult. However, it's easier to define the Web3 stack today—especially as blockchain technology continues to improve.

This guide offers an introduction to the Web3 technology landscape. Whether you're planning to build on the Web3 stack, or just curious to see how decentralized technology works under the hood, this is a good place to start.

What is Web3 And Why Does It Matter?

Before diving into the Web3 stack, it's important to grasp the meaning of Web3. Most of what we know about Web3 comes from this 2014 article by Gavin Wood, Ethereum co-founder and CEO of Parity Technologies.

For a short introduction to the topic, Web3 is essentially a collection of technologies that power the development of decentralized applications (dapps). Among other things, dapps benefit from decentralized control and distributed infrastructure, while offering users more control of identity and value.

Web3 is a vision of a decentralized Internet, built on blockchain technology. The current model of the Internet is highly centralized and more broken than most realize.

For instance, users must deal with data breaches, vendor lock-in, poor user experience, and so many problems associated with centralized infrastructure.

Web3 aims to solve most—or, at least some—of these problems. By removing power from centralized intermediaries, the Web3 stack promises a better user experience, increased data safety, and failure-resistant services.

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A Casual Introduction to the Web3 Stack

Although Web3 is vaguely similar to Web2, such similarities are fleeting. If anything, the Web3 stack is infinitely complex because blockchains—on which Web3 is built—are complex mechanisms.

Nevertheless, we'll attempt a breakdown of the Web3 application architecture. This section will go over the following building blocks of decentralized applications and how these systems combine to power a decentralized web:

• Blockchains
• Smart contracts
• Nodes
• Infrastructural primitives
• Frontend libraries
• Communication endpoints
• Access points (browsers and wallets)

Layer 1 (Blockchains)

At the bottom of the Web3 stack are blockchains. A blockchain is a digital ledger of transactions, maintained by a peer-to-peer network of nodes. This ledger also keeps track of on-chain data, such as account balances, smart contract code, and so on.

Beyond operating as a distributed ledger, blockchains also serve as "state transition machines." A state transition machine can compute an infinite amount of states, but can only be in one state at a time.

The rules governing state transition in a blockchain are defined by the consensus protocol, such as proof-of-work (Bitcoin) or proof-of-stake (Ethereum 2.0). Any transaction that fails to abide by these rules will automatically be rejected, which is why blockchains can function in the absence of a controlling entity.

Blockchains are critical infrastructure for decentralized web, as they facilitate the storage and execution of smart contracts (more on this later). For example, Ethereum—a popular blockchain for dapps—provides an execution environment (the Ethereum Virtual Machine) that allows developers to develop blockchain-based applications.

Other blockchains (state transition machines) useful for executing decentralized applications include:

• Polkadot
• NEAR
• Solana
• EOS
• Binance Smart Chain
• Avalanche

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Despite their benefits, blockchains often present many problems for applications. For instance, base-layer blockchains have slow processing speeds, limiting the functionality of dapps.

To circumvent this problem, developers have created several scaling solutions to achieve scalability whilst maintaining security and decentralization. These "Layer 2" solutions are designed to provide faster transactions and higher throughput to support increased usage.

Examples include:

• Polygon Network
• Optimism
• Arbitrum
• zkSYNC

Layer 2 (Smart Contracts)

Slightly above blockchains in the Web3 stack are smart contracts. Smart contracts refer to software programs that run on the blockchain.

A smart contract is autonomous, so it can execute operations automatically once the right functions are called. Most smart contracts are also immutable, preventing any alterations to the code once it is deployed on the blockchain.

In the context of Web3, smart contracts function as the backend of an application. The smart contract defines application logic and controls the overall functionality of the application.

Each time a smart contract function is called, it causes a change in the state of the blockchain network. Thereafter, the state change is accepted and broadcasted throughout the network of nodes.

This is where Web3 diverges from Web2. Traditional applications use a client-server approach where the code controlling applications is controlled by a company and can be changed at will.

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Because each smart contract lives on the blockchain, it cannot be deleted or stopped. This means dapps are censorship-resistant and cannot be unilaterally taken down by authorities.

Smart contracts are written in different languages, such as Solidity and Vyper (Ethereum and EVM-compatible chains) or Rust (Solana, NEAR, Polkadot).

To interact with smart contracts, users need to submit a transaction to the network, which is where nodes come into the picture.

Layer 3 (Nodes)

As explained earlier, a blockchain is essentially a p2p network sustained by globally distributed computers (nodes).

Each node validates transactions and verifies the state of the network. More importantly, nodes can parse on-chain data and send data to the blockchain as well.

For a dapp to connect to the blockchain (and interact with smart contracts), it must connect to a node. Typically, there are different alternatives here:

• Run a node
• Connect to a public node
• Use a node provider

Each method carries tradeoffs. For instance, running a node might be good from a decentralization standpoint (you can verify data yourself and reduce dependence on intermediaries). However, it can be expensive to run a node—especially as the blockchain continues to grow in size.

For this reason, many blockchain developers opt for node providers like Infura and Alchemy. Besides reducing overhead costs, node providers handle infrastructure management—allowing you to focus on building your dapp.

Each node runs a client software, which is just a protocol that enables interaction with blockchain data. Ethereum, for example, has different clients including Go Ethereum (Geth), OpenEthereum, and Parity.

Layer 4 (Technological Primitives)

Nodes, smart contracts, and blockchains mostly form the underlying structure for blockchain applications. However, another layer of critical infrastructure exists. This includes decentralized file storage, data feeds, and identity management.

Decentralized Storage

In Web2, 99.9% of application data is stored in a centralized database. Take a Web2 app, like Twitter, for example. Data that users generate—tweets, videos, pictures, likes, and account information—must be stored somewhere.

But centralized data storage is problematic for many reasons. It promotes undue and unauthorized exploitation of user data, exposes personal information to theft, and introduces the risk of censorship.

Since Web3 is designed to correct these problems, it needs an alternative storage system. With built-in security, trustlessness, and transparency, blockchains would be ideal for storing information. However, limits on block sizes make it impractical to store large amounts of data on-chain.

This is where decentralized storage networks come into play. A decentralized storage platform distributes files across a peer-to-peer network, ensuring the security and immutability of information. Unlike traditional databases, decentralized storage services are harder to shut down and protect privacy and control of personal information.

Thus, Web3 apps solve the data management problem by integrating with the decentralized storage solutions:

• Arweave
• IPFS
• Filecoin
• Storj
• Sia

Data Feeds

Dapps are great, but their real-world functionality is often limited. That's because smart contracts that power these applications can only access on-chain data (such as account balances).

For instance, building a decentralized prediction marketplace would be difficult since the dapp cannot extract information about event outcomes.

To solve this problem, blockchain developers use "oracles"—entities that collect real-world information from different sources and feed them to smart contracts. This allows smart contracts to execute based on the inputs they receive.

Using the previous example, you can see why data feeds (i.e., oracles) are important to blockchain applications. By integrating into an oracle service, like Chainlink, the prediction dapp can reward or penalize users based on the accuracy of their predictions.

Identity Management

Using applications requires proving our identity and permission to use the service. In Web2, identity management is centralized—third-party services ask for your personal information in exchange for access.

In Web3, identity management is decentralized. Instead of asking users to hand over personal information, authentication is done via cryptographic keys. To use a dapp, users will only have to connect their wallets or use a wallet-based ID service like SpruceID.

Layer 5 (Frontend Libraries)

Every application has a frontend, an interface from which users can activate the app's functionality. The frontend is also described as user interface (UI) and determines what happens when you interact with different elements.

In developer-speak, the frontend "talks" to the backend and initiates the specific functionality you requested. Let's use Twitter as an example:

Say you want to use the Search box to find an account. As you input the handle, the frontend communicates your request to the backend, which then returns information relevant to your search.

Many Web3 apps are similar to Web2 apps in how their frontend is built. For instance, many blockchain developers use JavaScript-based frameworks, like React.js, to build out their dapp's front-end.

The main difference lies in how the frontend applications in Web3 communicate with the backend. Because Web3 apps are built on a novel architecture (blockchains), they require different communication protocols.

Layer 6 (Communication Endpoints)

The Web2 Internet operates on a model comprising clients and web servers. A client can be a program or protocol that can send or receive information, while the server is responsible for storing and delivering the information.

Each time you visit a website or use an app, you're using a client (like your Chrome browser) to request information from a web server. This communication is governed by the HyperText Transfer Protocol (HTTP).

However, blockchain applications cannot use standard HTTP communication protocols since information is stored differently on blockchain networks. Unlike Web2's client-server infrastructure, blockchains rely on a distributed network of computers serving as mini-servers.

To interact with the blockchain, most dapps use newer communication endpoints, such as the ethers.js and web3.js libraries. These libraries help frontend applications interface with the blockchain and perform read/write transactions. This allows users to trigger smart contract functions by using an application's frontend.

APIs

Application Programming Interfaces (APIs) are another communication endpoint for blockchain applications. An API is a protocol that enables disparate systems to interact or “talk” to each other.

In the context of Web3 development, APIs allow dapps to fetch data from the blockchain for use in application logic. For instance, an NFT marketplace app may require NFT metadata, token records, and transaction information to execute specific actions on the frontend.

The Graph is an example of an API blockchain developers can use to retrieve critical blockchain data for applications. It uses ‘Graph Nodes’ to index on-chain information into various categories called ‘subgraphs’—which anyone can query for specific information.

The Graph quickly transforms smart contract events and function calls into information frontend applications can use, improving the overall experience (UI). Many dapps rely on The Graph’s functionality, including Aave, Uniswap, and Decentraland.

Note: There are other useful blockchain APIs, including Alchemy’s NFT API and Moralis API.

Layer 7 (Browsers and Wallets)

Web3 browsers and wallets serve as entry points for users to interact with decentralized applications.

Web3 Browsers

The average blockchain application is usually available as a Web app, so you can only access them via browsers. However, the average browser—say, Google Chrome—cannot interact with a dapp for reasons explained earlier.

To solve these problems, users rely on dapp-specific browsers like Brave, Status, and Opera or browser extensions like MetaMask. These browsers have native support for parsing blockchain information, so you can read/write transactions from your browser.

For instance, MetaMask is a browser extension that injects web3.js into each webpage, making it possible to fetch on-chain data and also send transactions from your browser.

[Image source]

Wallets

While you can easily read blockchain data from your dapp browser, sending transactions requires signing with a private key. As such, wallets are crucial for interacting with blockchain applications.

As explained earlier, calling smart contract functions involves paying a fee to miners responsible for executing the transaction. Wallets allow users to store and send cryptocurrency, making them necessary for interacting with smart contracts.

Some browsers, like MetaMask, also serve as wallets; in this case the browser stores private keys on the device. Each time a user triggers a specific dapp functionality, a confirmation screen will appear in the browser window, asking them to sign the transaction.

Final Thoughts

This list is by no means exhaustive—the Web3 landscape is ever-changing and new tools are always popping up. Nevertheless, the components discussed in this article form the core infrastructure of the Web3 development stack.

Although Web3 technology may seem complex, the stack is important for realizing the vision of decentralization. With these technologies, we can build a better Internet that offers users greater sovereignty and improves the overall experience.

Shareholder activism is hardly a new concept. For example, activist investors like Carl Icahn attracted significant attention in the 80s for aggressively pushing for change at portfolio companies.

Shareholder activism has become more popular in recent years, as investors find ways to coordinate and express their views on company issues. Today, activist investors promote positive changes, such as greater institutional commitment to environmental sustainability and diversity and inclusion, financial transparency, and more.

[Image source]

However, the flawed nature of modern corporate governance limits the effectiveness of shareholder activism. Problems such as centralization of decision-making and inadequate participatory mechanisms reduce investor capacity to have their voice heard in corporate settings.

Decentralized autonomous organizations (DAOs) are a new class of institutions that democratize corporate governance. DAOs operate on peer-to-peer protocols (like blockchains) and abandon hierarchical structures in favor of vertical power distribution. With their decentralized nature, DAOs can empower investors and create favorable conditions for shareholder activism.

But, before we go further, let's look at shareholder activism in detail.

What is Shareholder Activism?

According to Investopedia, a shareholder activist is "a person who attempts to use their rights as a shareholder of a publicly-traded corporation to bring about change within or for the corporation."

The objectives of shareholder activists can vary between the financial (increasing investor dividends) and the non-financial (promoting employment diversity). Whatever the motive, shareholder activism is a major tool for investors to express their views on matters concerning a company.

Mark Mobius, whom we earlier quoted, said of shareholder activism:

"When we invest in a company, we own part of that company and we are partly responsible for how that company progresses. If we believe something is going wrong with the company, then we, as shareholders, must become active and vocal."

[Image source]

Shareholder activism exists because investors cannot always trust company management to act in their best interests. This problem is captured in a strand of political-economic theory known as the "principal-agent problem."

In a principal-agent arrangement, the agent is allowed to make legally binding decisions on behalf of the principal. However, a problem occurs when the interests of the agent aren't aligned with those of the principal. Rogue agents may use their proxy power to authorize decisions that benefit them at the expense of principals.

The principal-agent problem is often on full display in companies where the agent (an elected board of directors) may be at odds with the principal (shareholders). In absence of effective checks, company directors might pursue policies that harm investor interests.

Shareholder activism prevents corporate management from running rampant and executing selfish action (like taking fat compensation packages). However, modern-day shareholder activists need better tools if they are to successfully force change.

The Many Problems of Traditional Corporate Governance

In most cases, investors looking to participate in company decision-making have to wait until the Annual General Meeting (AGM). The AGM is a yearly ritual with the outlined purposes of providing up-to-date information on company activity, enabling discussion, and facilitating voting on important decisions, like mergers or appointments.

AGMs are ideal for shareholder activists because it provides a forum to air concerns and, more importantly, allow them to table or vote on proposals. However, modern-day AGMs fail to deliver on their promises and stifle shareholder participation.

[Image source]

For starters, the limited timeframe of these yearly meetings makes it impossible for an extended discussion on issues. With mere hours to cover a large agenda, activist investors may be prevented from sparking a debate around pressing matters.

We also have the problem of logistics. Not every investor is able—or willing—to travel miles to a company's HQ to sit through a half-day meeting. Doing so may be sensible for large shareholders, but smaller shareholders may deem the cost too high, leading to massive declines in turnout at shareholder voting sessions.

Companies have tried to solve this problem by introducing proxy voting. Here, investors receive documents outlining issues under consideration, before the meeting. They can choose to vote on these proposals through mail or via the agreed electronic system.

However, proxy voting has flaws. For instance, there's no way for shareholders to verify if votes were correctly counted and ballot results represent the majority's wishes. The notorious case of Procter & Gamble vs Nelson Peltz illustrates this point:

On the heels of its 2017 shareholder meeting, Procter & Gamble announced that shareholders had voted to reject activist investor Nelson Peltz's bid to join the company's board of directors. However, an independent audit disputed P&G's claim and instead awarded the victory to Peltz, leading to the latter's appointment to the board.

[Image source]

Scenarios like the one described above discourage well-meaning investors from exercising their rights as part owners of a company.

We have seen the major problems with modern-day governance, namely:

• Annual shareholder meetings are limited avenues for discussion due to their short duration
• Logistical costs (time, travel, effort) prevent shareholders, especially retail investors, from participating in meetings
• Proxy voting systems are susceptible to mismanagement and may disenfranchise voters

These problems exist because the thinking around companies and governance has remained unchanged for years. For example, article 70 of the UK's 1856 Joint Stock Companies Act states:

"Once at the least in every year the directors shall lay before the company in general meeting a statement of the income and expenditure for the past year, made up to a date not more than three months before such meeting."

What's surprising here is that sections of the 2006 UK Companies Act contain very similar provisions. These two laws may have been enacted centuries apart, but they share the same flawed thinking.

Improving corporate governance and enhancing shareholder activism in corporations requires novel solutions that empower stakeholders and facilitate transparent decision-making. As Albert Einstein noted, "we cannot solve our problems with the same thinking that created them."

This is where DAOs come into the picture.

Why Shareholder Activism Needs DAOs

A DAO is a collective of individuals who pool resources together to achieve specific objectives. This could be governance (Aragon), provision of financial services (MakerDAO), or in the case of BanklessDAO, media production and education.

DAOs are like companies, except they operate differently. Instead of issuing shares, a DAO sells tokens to prospective members (investors). These tokens confirm holders' membership of the DAO and empower them to participate in governance.

In a DAO, power is distributed across the membership. Every decision must be ratified by the majority of token holders, and no entity can arbitrarily make decisions on behalf of others. Moreover, any member can initiate proposals and seek support from their colleagues.

The rules governing a DAO are encoded into a smart contract and recorded on a transparent and immutable blockchain, preventing any alterations (except when agreed on by the majority). Voting is conducted on-chain, with DAOs allowing stakeholders to cast their votes in an open, decentralized, and secure process.

An example DAO governance process. [Image source]

DAOs solve the principal-agent problem by distributing decision-making power across board. There is no board of directors or CEO calling the shots and pulling the strings for private benefits.

More importantly, DAOs streamline corporate governance and make it easier for investors to initiate or weigh in on proposals. DAOs are location-agnostic institutions and mostly operate through online forums and social networks like Discord. This reduces participation barriers, promoting higher stakeholder engagement in discussion and decision-making.

Besides, DAOs encourage members to submit proposals and give feedback regularly—which means no one has to wait months to table important matters before other stakeholders.

The case involving the Ethereum Name Service (ENS) and its Director of Operations Bryant Millegan is a good example of how DAOs make it easier to call for changes in an organization.

After Millegan was accused of homophobia and misogyny over a series of resurfaced tweets, DAO members initiated a proposal for his removal. Here's a screenshot showing the final results of that proposal:

Now, Millegan eventually held on to his position because the majority voted in his favor. But to focus on the failure to remove him is to miss the forest for the trees.

In a traditional organization, a proposal to remove a high-ranking member would've been a drawn-out process doomed to fail. Or, the decision would've been placed in the hands of a board whose decision may fail to reflect the majority's wish.

However, the ENS DAO's flexible governance structure allowed members to initiate a proposal for change. More importantly, it allowed the entire community to coordinate and express their position on the issue seamlessly.

This is why DAOs matter for activist investors.

Finally, it's important to note that the use of on-chain voting in DAOs increases the integrity of shareholder voting. Thus, it becomes difficult for the management to manipulate results to block activist efforts, as P&G did with Nelson Peltz.

Already, voting tools like Snapshot and Tally ease voting on proposals for DAO participants. Since blockchain transactions can be viewed by anyone, voters can verify results for themselves. And cryptographic security mechanisms make information stored on blockchains immune to alteration.

Why Don't We Just DAO It?

The idea of using blockchain technology to improve corporate governance has old origins. In his 2016 Council of Institutional Investors Keynote Speech, Vice Chancellor J. Travis Laster called modern shareholder voting a 'daisy-chained system of share ownership', describing blockchain technology as a "superior external solution" to problems confronting corporate governance.

While early experiments at mixing company ownership with blockchains, such as The DAO), failed—the industry has matured since then. Today, there are more DAOs than ever, bringing together people from different backgrounds to coordinate and produce value.

If applied correctly, DAOs have the potential to give power back to investors and strengthen their capacity to positively influence company policies. Shareholder activism won't be limited to hedge funds and deep-pocketed investors anymore; retail investors, too, can make their voices heard on issues.

There's still a long road before DAOs become mainstream and provide these benefits. However, if the last years have shown us anything, it's that transformation is starting to happen quickly. With time, DAOs may replace traditional companies—and shareholders will be better off for it.

Cover image courtesy of Financial News

While the infamous DAO hack of 2016 dampened enthusiasm for blockchain governance, the growth of several projects shows DAOs can become a new force in traditional economies.

But before that can happen, DAOs must solve a teething problem: governance.

Every organization, even decentralized ones, must coordinate to decide on critical issues. The success or failure of any DAO depends on how well it can achieve governance objectives in a secure, transparent, and fair manner.

Why Does Governance Matter For DAOs?

In traditional organizations, the Board of Directors or a smaller group of C-Suite executives are usually responsible for decision-making. While centralized control promotes efficiency, years of management problems have revealed flaws inherent in traditional governance.

One such flaw is the so-called "principal-agent problem." In economics, the principal-agent problem occurs when the interests of individuals (principals) and representatives deciding on their behalf (agents) are misaligned. For example, directors may chase short-term profits, which benefit them, at the expense of long-term growth that benefits investors.

Decentralized autonomous organizations were formed to democratize decision-making. By distributing power across the organization, DAOs hope to align the interests of members and ensure that no individual or group can pursue selfish objectives.

DAOs primarily achieve this aim by using tokens to facilitate governance. Buying tokens signals a commitment to the DAO, and by extension, fitness to participate in governance.

Holding a DAO token imbues the holder with significant influence on the organization's direction. For example, DAO members can call for changes by submitting a proposal. In other words, a token functions like a share in a traditional company.

Armed with tokens, DAO members can express their opinion on several issues requiring consensus. Usually, DAO voting sessions are executed on-chain, which provides a higher level of transparency and security than regular balloting systems.

Examples of governance tokens. [Image source]

DAO governance can serve some or all of the following purposes:

Asset Management: DAOs often raise initial capital via token sales, with the remaining funds deposited in a treasury. However, as the DAO grows its user base and cash flow, it needs to manage the allocation of funds for projects.

HR Processes: Even a DAO needs a group of people to lead certain areas. However, the difference is token holders have full control of the election and ouster of officials. For example, the Ethereum Naming Service (ENS) DAO recently asked members to vote on a proposal for the removal of its director, Brantly Millegan.

Protocol Decisions: Governance tokens can be used to vote on proposals concerning the operation of a network. For example, members of the TerraDAO voted to burn an agreed number of Luna tokens and mint more TerraUSD stablecoins.

Governance is a critical part of DAO infrastructure. Even though these organizations have fluid structures, a decision-making framework is important. Otherwise, it may be impossible to reach a consensus on matters critical to the DAO's growth.

Challenges With Traditional DAO Voting Protocols

Most early DAOs adopted a token-based system of governance ("one token, one vote"). In this system, higher influence on DAO governance required a higher level of financial commitment. This arrangement ensured individuals with a proven commitment to the health of the DAO had greater input in running it.

Token-holder voting systems provide a simple, safe, and transparent way for DAOs to make decisions. Once a proposal is up for discussion, members can cast their "votes" on-chain and verify the results. There are no hidden election processes; everything is right there on the blockchain for everyone to see.

But, as innovative as they are, 1T1V systems may pose problems:

Centralization

In a hypothetical scenario, wealthy individuals can buy up governance tokens to accumulate undue influence within the DAO. If the said individual has less-than-benign intentions, the future of the DAO may be threatened.

This problem was on full display during the Steem-Tron saga of 2020. Decrypt has a much more detailed breakdown of the dispute, but here's a TL;DR version:

Justin Sun, the owner of Tron blockchain, bought social media blockchain Steem. However, community members were unaware of the deal, and understandably, rejected Tron’s takeover of Steem.

Now, Steem is a delegated proof-of-stake protocol where token holders can vote on the selection of "Witnesses". Witnesses are "supernodes" responsible for securing the blockchain and validating transactions on the Steem blockchain.

[Image source]

Witnesses have an outsized influence, such that anyone who controls the Witnesses controls the network.Thus, Witness selection became the new battleground for Justin Sun and community members opposing the takeover.

In a protracted battle worthy of the Netflix treatment, Sun and hostile Steem holders entered a slugfest to wrest control of the blockchain. Each camp accumulated eye-popping amounts of tokens to secure Witness positions for their preferred representatives. Benefiting from a large war chest, Sun (himself a billionaire) succeeded in electing his Witnesses, effectively taking control of Steem despite overwhelming opposition.

Similar problems have surfaced in EOS, another blockchain where 'Delegates' are elected to validate blocks. Certain individuals buy tokens, and even collude with exchanges to use tokens belonging to others, to vote for select representatives.

In these cases, token-based governance degenerates into a form of plutocracy where wealthy elites control power. Which goes against everything that on-chain governance and DAOs promise.

Rational Indifference

If tokens held = voting power, then it follows that DAO members with smaller token holdings may have lower incentives to participate in governance. An individual may see their influence on proposal outcomes as minimal and rationalize refusal to participate in voting.

"Rational indifference", as it's known, can discourage DAO members from active participation, leaving token whales at the helm of governance. This re-introduces the principal-agent problem and negates the essential value-proposition for DAOs: putting power in the hands of every stakeholder.

Rational indifference may also make collusion easier. With little incentive to vote on proposals, DAO members can sell their governance tokens to the highest bidder for voting purposes. Or, they can "lend" their tokens via flash loans and re-acquire them after the other entity might have used them to influence voting outcomes.

Incompetent Leadership

In a DAO, policymaking may be crowdsourced and open to anyone holding governance tokens. While this ensures every stakeholder has input in policies, it may give rise to a kakistocracy—leadership by the least competent—especially if the wrong individuals acquire the lion's share of tokens.

English author Douglas Adams once quipped: "It is a well-known fact that those people who most want to rule people are, ipso facto, those least suited to do it." With governance tokens circulating on the open market, entities can effectively buy their way into power.

Such individuals may not necessarily have the competence or expertise to justify their influence on decision-making. Worse, they may be aligned against the interests of the larger collective in the DAO.

For example, a shadowy investor hoping to profit from shorting a DAO's tokens may deliberately destabilize governance mechanisms. The threat of "dark DAOs", malicious groups coordinating to exhibit undue influence on DAOs through token accumulation, is extensively covered here.

This problem, known as the Tragedy of Commons, already exists in traditional economies. And it looks like DAOs may be the next victim of the selfish or unwise behavior of a small group.

Can DAO Governance Improve?

Finding a governance mechanism fit for purpose is a difficult task. The right DAO voting protocol must account for the problems discussed in the preceding section, a task easier said than done.

Nonetheless, there are various experiments in the ecosystem to improve the current governance process. This section will discuss some of these alternatives to traditional 1T1V systems and consider their utility:

1. Delegated Voting/Liquid Democracy

Sometimes, DAO members can be indifferent to proposals simply because they don't have the mental bandwidth to understand the issues at stake. Especially if the said individuals treat participation in a DAO as a part-time activity, they may be unwilling to commit the time necessary to decide on important matters.

To mitigate such problems, delegated voting aka "liquid democracy" is a possible solution. Delegated voting is just that—delegating an individual to vote on your behalf. In this case, the delegate is likely a reputable member of the DAO or an individual with proven expertise on the issues under consideration.

Delegated voting using Tally. [Image source]

Aragon is among the high-profile DAOs to use delegated voting to solve governance-related problems. Liquid democracy encourages competent decision-making, since power is linked to their reputation or expertise, not token holdings. Plus, delegated voting may theoretically produce decisions that reflect the wishes of the community.

"But doesn't delegated voting introduce the same issues as coinholder voting?"

Delegated voting can indeed increase the possibility of collusion, bribery, and the infamous principal-agent problem. However, well-designed delegated voting systems can be an improvement on existing voting protocols.

For starters, DAO members can withdraw their delegated powers anytime they wish. This contrasts with corporate governance mechanisms where removing a rogue Board of Directors can prove difficult.

Thus, it becomes near-impossible to coerce individuals or suppress opinions since token holders can choose to exercise their rights. This also keeps delegates accountable to members of the DAO and mitigates the “principal-agent” problem common in traditional governance.

2. Holographic Consensus

Holographic consensus is a voting system developed by DAOstack to scale DAO governance. Right now, there are DAOs with thousands of members, and getting members to vote on every proposal can be difficult, if not outright impossible.

The thinking behind holographic consensus is that attention spans are limited, so only the most important proposals should come up for voting. Proposals deemed unnecessary can be screened out, ensuring that the attention of DAO members is harnessed properly.

Holographic consensus uses a cutting-edge process that combines elements of prediction markets with DAO governance. Here's how that works in practice:

• Governance is facilitated through DAOstack's collective attention token, GEN. Token holders cannot vote on proposals, but they can 'bet' on which proposals are likely to succeed. If the proposal passes, holders get rewarded with more GEN tokens. But if the proposal falls through, their GEN holdings are slashed.

• Any DAO member who meets the required specifications can initiate a proposal. Proposals that receive high GEN bets are 'boosted' and pass to the next round. At this stage, proposals with low GEN bets are screened out.

• Proposals from Round 1 are voted on by members with voting rights. GEN holders can either make profits or losses on their bets depending on whether their choice proposal passes or not. Afterward, approved proposals are executed and implemented in the DAO.

[Image source]

Holographic consensus makes sense for several reasons. It reduces voter fatigue, which occurs when individuals are required to vote too many times. In HC-enabled governance, DAO members can concentrate on high-stake proposals and quickly decide on them.

Moreover, it prevents malicious individuals from attacking a DAO by initiating nefarious proposals. A would-be attacker needs to boost a proposal, which means spending their money to buy GEN tokens. That increases the cost of attack and may discourage governance attacks on DAOs.

However, there are questions over the perceived usefulness of holographic consensus. Holographic consensus introduces complexity into DAO governance, and members may find the learning curve too steep.

Besides, nothing rules out GEN holders from holding governance tokens. This leaves the door open for bettors to influence the results of the voting. After all, they have everything to lose if their boosted proposal fails to go through.

3. Weighted/Reputation-Based Voting

Earlier, we explored the problem of outsiders, such as crypto whales, buying governance tokens to exercise undue influence in a DAO. In this scenario, someone disinterested in the long-term survival of the collective can accrue enough power to destabilize it for selfish gain.

To prevent this problem, some DAOs are using weighted and/or reputation-based voting systems. These two concepts are somewhat similar, although differences remain.

In weighted voting schemes, the voting power of tokens depends on how long they've been held. Weighted voting schemes incentivize holders to lock up their tokens to improve the utility of their votes.

Weighted voting schemes make it harder to acquire voting power in a DAO. You can't just borrow governance tokens from the market and immediately use them to influence voting results. This won't rule out governance attacks entirely, but it significantly increases the cost of executing one.

Weighted voting in Kusama parachain. [Image source]

The reputation-based voting system follows a similar pattern. Here, DAO members get a single, non-transferable token specifically for voting on proposals. And the voting power attached to each token is linked to the reputation of its holder.

'Reputation points' can be earned in different ways. A DAO may reward individuals with reputation points according to their membership history. Or, members can earn more reputation points by contributing positively to the organization's growth (for example, by completing tasks).

Reputation voting can ensure individuals with a rich history of participation in the organization acquire great influence. This means an outsider will find it cumbersome to infiltrate the DAO through governance mechanisms.

However, reputation voting may be deemed unfair in certain instances. For example, what if a reputable member suddenly goes rogue and uses their influence in the organization for malicious purposes. Wouldn't reputation systems just re-introduce the Tragedy of Commons?

Because someone acquired reputation points during the early phase of a project doesn't mean they should hold leadership status forever. Especially if their contribution declines, it'd be unfair for genesis members to wield more power than new but active members.

There are two possible solutions here. First, DAOs can make reputation points revocable. If a member is guilty of misconduct, their reputation points should decline to reflect that.

Second, reputation points can be programmed to reduce over time, or even expire. This solves the problem of unfairness and keeps power in DAOs fluid.

Reputation systems have other flaws, though. Anyone can sell their private keys to transfer reputation (reputation points are linked to wallets). Still, it's difficult to form a thriving market around the sale of reputation points, so this is a viable mechanism for promoting effective DAO governance.

4. Quadratic Voting

Quadratic voting is a novel governance mechanism that’s gained support from the likes of Ethereum founder Vitalik Buterin. Quadratic voting is appealing because it offers an alternative to coinholder voting and reduces the influence of whales on voting outcomes.

In a quadratic voting scheme, everyone gets one vote once on a proposal. However, they can purchase more “credits” to cast more votes for their preferred option.

"Wait, isn't that essentially what 1T1V systems do?"

Well, not exactly. In a 1T1V system, the cost of additional votes is linear. If you need five extra votes, you just need five more tokens. In a quadratic voting system, the cost of additional voting is quadratic; one vote costs one token, two votes cost four tokens, three votes cost three tokens, and so on.

[Image source]

Quadratic voting allows individuals to express the extent of their support for a proposal by purchasing vote credits. This makes quadratic voting the DAO version of "putting your money where your mouth is."

At the same time, it reduces the influence of crypto whales in decision-making. From our earlier example, it's obvious that the utility of additional voting decreases, while costs increase. It'd take a lot of money for a dark DAO to acquire enough tokens to distort outcomes.

Of course, that doesn't rule out vote-buying. Quadratic voting even makes token-buying more lucrative since first votes count for a lot.

Projects like Gitcoin DAO alleviate this problem by using stringent identification systems that make it difficult to transfer voting rights. For instance, users have to register a profile with decentralized identity services like Proof of Humanity, BrightID, Ethereum Naming Service (ENS), and Idena.

Final Thoughts

In its current form, DAO governance is far from perfect. But the sector is investing in novel governance mechanisms to achieve higher member participation, equitable distribution of power, and efficient decision-making.

Whether experiments like quadratic voting and holographic consensus will replace traditional coinholder voting is up for debate. Nonetheless, we can expect DAOs to keep reiterating until they find the ideal governance system that promises the most benefits to members and the larger ecosystem.

Ethereum’s switch from a proof-of-work to proof-of-stake consensus mechanism has several implications for its future. With the Beacon Chain as a consensus layer, Ethereum PoS promises better network security, energy efficiency, scalability, and decentralization.

However, it also introduces new challenges that could threaten Ethereum’s functionality.

One of those challenges is achieving ideal client diversity. In a decentralized network like Ethereum, diversity of client software is necessary for enhancing network security, functionality, and censorship resistance.

However, current stats show that Ethereum's PoS consensus layer (the Beacon Chain) is lacking in the client diversity department. As we'll find out in this article, centralization of software implementation has critical implications for the Ethereum ecosystem.

ELI5: What Does Client Diversity Mean?

Ethereum is a decentralized peer-to-peer network sustained by a globally distributed collection of nodes (i.e., computers). Each node runs a “client”—this is software that helps nodes to interact with the Ethereum blockchain. Without clients, nodes cannot broadcast and verify transactions, execute smart contracts, or reach consensus on the blockchain state.

Clients are a critical part of Ethereum’s infrastructure, which is why its developers opted for a multi-client arrangement. As opposed to running a single client, nodes are incentivized to run different client implementations—the end goal being that no client should hold a supermajority.

Client diversity simply means having a fair distribution of client software on network nodes. Ideally, no client should power more than 33% of nodes in a decentralized system like Ethereum. Or else, several bad things (which we explore later) can start to happen.

Currently, Ethereum's Beacon Chain doesn't have an equitable spread of client software across nodes running the network. As the chart below shows, the majority client controls > 68% of validators, which can put the system at risk for different reasons.

[Image source]

Client diversity is a hotly debated topic in the Ethereum community. And that's due to its importance to Ethereum's performance, especially in the context of the Merge. The debate also exists because of disagreements on how client diversity should be realized.

So, why exactly is client diversity so important? That's what we're about to find out.

The Importance of Client Diversity

As a distributed system, Ethereum relies on the network of peer-to-peer nodes to function optimally. In turn, those nodes rely on clients to help them contribute to the network.

Any flaws or bugs in client software will affect a node's participation in the network. If the problem is constrained to one client, then the network can continue to function. Other nodes running alternative clients will manage the blockchain, while the affected nodes can switch to a non-affected client.

The above scenario can only work if, and only if, a small number of nodes are using the affected client software. A case where the majority of nodes run the malicious software could create single points-of-failure and affect the network significantly.

Here are some potential problems that could happen in this case:

Restrictions on Transaction Finality

Finality in blockchain lingo is a guarantee that transactions cannot be reversed, altered, or canceled. If a blockchain finalizes, committed blocks cannot be revoked.

Finality is what gives Ethereum, and other blockchain networks, their "immutable" quality. Anyone can use Ethereum knowing transactions will be recorded permanently on the chain and cannot be tampered with.

Typically, blockchain networks need the majority of nodes to reach consensus before achieving transaction finality. In the Beacon Chain, at least 2/3 of staked ETH is required to finalize the chain. Anything lower than that, and the chain cannot finalize—putting the system in jeopardy.

So, how does this relate to flawed client software? Well, you have to consider what can cause a situation where nodes are unable to reach consensus.

We could think of different reasons, but the most realistic one is simple: validating nodes are malfunctioning. If 1/3 of validators are inactive, then there wouldn't be a 2/3 supermajority required for Beacon Chain finality.

To remedy the problem, the Beacon Chain activates the Inactivity Leak Mechanism. This mechanism is designed to gradually reduce the stakes of offline validators, allowing the remaining nodes to re-form a two-third majority.

If all goes well, the remaining nodes can achieve consensus and keep the chain running. In this scenario, the heaviest losers are validators who have their ETH stakes slashed.

Network Split

The preceding section explored what could happen if a faulty client powers more than 1/3 of validating nodes. But, that’s only the beginning—worse things can happen, especially if > 1/2 of validators are running the bad client software.

In this case, the Beacon Chain network can split into two separate chains. Both chains will be unable to finalize because half their validators are missing; hence, the Inactivity Leak mechanism will activate.

Deposits belonging to affected validators will get destroyed over a while—three to four weeks, say—until they control less than 1/3 of staked ETH. The result is that the old and new chains will finalize independently, making it hard to merge them later.

To merge both chains, the community would need to agree on the canonical chain—a process likely to be fraught with politics. The reason is simple: asking validators to join another chain would cause them to lose their entire stakes.

A network split would force over half of the community to suffer huge economic losses. To avoid this fate, validators on the discarded chain may decide to continue running the forked chain, splitting the Ethereum community.

This is reminiscent of the events surrounding the DAO hack of 2016 when a faction—disgruntled with the handling of the situation—forked the network and created Ethereum Classic. Not only would a split weaken Ethereum, but it could depreciate the price of ether on the market.

To prevent a network split, developers would need to quickly patch the consensus bug before each chain finalizes. Otherwise, it’d become difficult, if not impossible, to ever merge both chains into one canonical chain.

Reversing Transactions

If a faulty client running > 1/2 of Beacon Chain validators is catastrophic, then a situation where > 2/3 of nodes use the same vulnerable software is Armageddon. A new chain comprising nodes with the affected client will split from the Beacon Chain and—because it has a 2/3 supermajority—finalize independently. At most, developers will have ~ 13 minutes to patch the software before the split chain achieves finality.

This is assuming the developers are nice guys who genuinely love Ethereum. If the developers go rogue—or malicious actors infiltrate the organization—they can hijack the chain and do considerable damage. They could very well rewrite the entire blockchain history (and double-spend funds), censor transactions, or even reverse old transactions.

Even if the bug were an honest mistake, the situation would still be less than ideal. Let’s look at some hypothetical scenarios in this case:

Fix #1

One way to fix this problem is to have nodes accept the bug as the normal behavior of Ethereum. What that means is that unaffected nodes will reproduce the bug and try to join the other chain. Afterward, developer teams can coordinate on a fix, and stakers can update their client software to reflect the change.

But this isn’t an easy solution to implement. First, unaffected nodes will be punished for inactivity even if they acted honestly. Second, this fix only covers trivial errors; severe consensus bugs would make the corrupted chain incompatible with the rest of the network.

This brings us to the second solution.

Fix #2

Another option in this event would be to patch the vulnerable client. However, there’s no way validators running the once-faulty client can safely rejoin the canonical chain without getting penalized. Here’s why:

Due to a large number of validators exiting their stakes on the compromised chain, the Inactivity Leak mechanism will activate. Which means affected validators can lose a lot of money, especially because exits can be painfully slow.

Now, this is the point where I say, “but wait, there’s more!”. Let’s imagine the affected validators successfully exit the bad chain and attempt to rejoin the correct chain. Because they already attested to one chain, any attempt to attest to another unfinalized chain would lead to a slashing of their ETH stakes.

In other words, we have a dilemma on our hands:

If the affected validators voluntarily exit their stakes, they’ll likely get caught up in the inactivity-related slashing. If they try to join the ‘good’ chain immediately (when it hasn’t finalized), their stakes get slashed per protocol rules.

In the end, no one benefits from having this problem happen. Which is why a client controlling more than 2/3 of validating nodes is cause for alarm.

Can Ethereum Client Diversity Improve?

By now, the importance of diversity to the health of the Ethereum network should be obvious—especially if we want to keep Ethereum decentralized. But, if the numbers are anything to go by, Ethereum’s Beacon Chain is yet to achieve a fair distribution of clients.

The dominant client, Prysm, controls > 68% of nodes on the Beacon Chain, putting us firmly in Armageddon territory. It may seem alarmist to raise concerns over a single client having a supermajority, but these problems are from being hypothetical.

In August 2020, Medalla (a Beacon Chain tesnet) suffered a major crash. The reason? Nodes running Prysm software malfunctioned due to a clock bug in the client. As a result, Prysm nodes went offline, leaving the chain unable to finalize.

Developers finally fixed the problem hours later, but not before validators lost their stakes due to slashing. If the majority of nodes hadn’t been using the same software, then the problem would have been corrected easily.

The Medalla tesnet fluctuated below the 2/3 majority needed for finality. [Image source]

History also shows why client diversity is important. For example, in 2016, hackers targeted Ethereum with a distributed denial-of-service (DDoS) attack by exploiting vulnerabilities in the Go Ethereum (Geth) client. The network survived because nodes could switch to the Parity client which was safe from the attack.

Client diversity is hard to achieve because nodes cannot be unilaterally forced to run a particular client. Moreover, dominant clients usually enjoy first-mover advantages and network effects, making them hard to displace.

Nonetheless, there are various possible solutions for improving software diversity:

Protocol Incentives

Ethereum’s Casper PoS mechanism, which controls the Beacon Chain, is designed to discourage majority use of a particular client. It incentivizes client diversity through anti-correlation penalties and quadratic inactivity leak fees.

Quadratic Inactivity Leak

If you’ve read the article up until this point, you may be familiar with the quadratic inactivity leak. Typically, validators on the Beacon Chain can get penalized for dishonest activity or failing to perform their duties (e.g. going offline).

Standard inactivity penalties are low (around 1 ETH) and validators will still have most of their stake intact. However, if > 1/3 of validators are inactive, things start to look different. The chain cannot finalize in this situation, which threatens liveness—an indispensable quality for all distributed systems, not just blockchains.

In a quadratic leak scenario, inactivity fees will increase quadratically until offline validators have their stakes reduced to less than 1/3 of the network. The rationale is that, if anything knocks a large number of validators offline, the chain can still achieve finality.

Remember that we need 2/3 of stakers to reach consensus for the Beacon Chain to finalize? The Inactivity Leak mechanism will ensure that offline nodes hold less than 1/3 of stakings, allowing remaining validators to create the required two-thirds supermajority.

The implication is that if you run the dominant client, your node will likely go offline during the inactivity leak. This means you’ll lose ETH like crazy until the bug gets fixed and liveness is restored to the chain.

Anti-Correlation Penalties

In addition to encouraging software diversity, anti-correlation penalties are designed to prevent the possibility of malicious collusion. The quadratic inactivity leak is a type of anti-correlation penalty, although the punishments discussed in this section are heavier.

The first anti-correlation penalty touches on validators producing bad attestations, i.e., validating malicious transactions. If a majority client experiences a bug that causes validators to give false attestations, they’ll lose 100% of their stakings. In other words, the more nodes that act maliciously, the higher the penalty.

The second anti-correlation penalty touches on validators attesting to an invalid block. This is something we’ve explained earlier, but we’ll look at it again.

If an invalid block is committed to the beacon chain, other nodes will reject it and form a new chain that doesn’t have the block in it. The only option for nodes on the valid chain is to switch to the correct chain; however, this attracts a penalty, as a significant percentage of ETH stakings get slashed.

These incentives are put in place to promote a multi-client culture in Ethereum. As such, validators are encouraged to run minority clients.

Running Minority Clients

The more obvious step to achieving better client diversity is getting nodes to run different clients. By running different software, validators can ensure Ethereum remains robust, secure, and functional.

Moreover, running a minority client is in your best interests as a validator—especially with anti-correlation penalties and inactivity leak fees. You won’t necessarily escape punishment by running a minority client, but the penalties will be lower.

These are some minority consensus clients you can run:

• Lodestar
• Teku
• Nimbus
• Lighthouse

We’ve focused squarely on consensus clients, i.e. Beacon Chain nodes, in this article. However, Ethereum Mainnet has a similar problem. Per stats, Go Ethereum (Geth) controls > 80% of nodes, with Nethermind, OpenEthereum, and Erigon trailing with low figures.

[Image source]

Since the execution layer is as important as the consensus layer, it needs client diversity as well. To solve the problem, nodes on Ethereum Mainnet can run the following execution clients:

• Hyperledger Besu
• Nethermind
• Erigon
• CoreGeth

Final Thoughts

Beyond the immediate security benefits, client diversity can create a richer Ethereum ecosystem. Each client works with different languages, design features, and architectures, inspiring greater innovation and exchange of ideas.

As Ethereum undergoes the biggest change since its inception, it is important to encourage diversity across the network. Only then can it remain a robust and highly functional decentralized system.

References

1. Validated, staking on eth2: #1 - Incentives

2. Ethereum Merge: Run the majority client at your own peril!

3. Eth2book: The Incentive Layer

Cover image courtesy of Getty Images

Non-fungible tokens (NFTs), decentralized finance (DeFi) platforms, blockchain games—all of these rely on smart contracts to work. However, smart contracts themselves can only run because the Ethereum Virtual Machine (EVM) exists.

The EVM is a computation engine that facilitates the deployment and operation of smart contracts. Without the EVM, it’d be impossible to execute software programs on the Ethereum protocol. Thus, the EVM is a critical part of Ethereum's core architecture.

This article offers an introduction to the Ethereum Virtual Machine (EVM). We cover the basics of the EVM, including components of its structure—like opcodes and smart contracts.

What is the Ethereum Virtual Machine (EVM)?

To understand the Ethereum Virtual Machine, we must explore two concepts first: "virtual machines" and "Turing completeness."

Virtual Machines

Virtual machines are programs that simulate the behavior of a physical computer. A virtual machine has its storage and processing unit and runs as a process on your PC. It's a bit like having a computer running on another computer.

A VM is similar to your average Windows or MacOS software. The difference here is that VMs are designed to perform more high-level functions. Moreover, a VM—unlike a regular OS—has no access to other parts of your computer, like the storage or bandwidth.

If you've played Android games on a PC using an emulator, then a virtual machine may be familiar. While emulators and VMs are significantly different, they are both approximate the powers of hardware and can execute code in a “sandboxed” environment.

Turing Completeness

British Mathematician Alan Turing developed the first Turing Machine—the forerunner of today's computer. A Turing-complete machine can process any computation, no matter how complex, provided it has enough time and resources.

Now, let's tie these ideas together and define the Ethereum Virtual Machine:

The Ethereum Virtual Machine (EVM) is a giant virtual machine that allows for the deployment and execution of code. You only need to install the necessary client software to access the EVM and use it to execute programs on Ethereum. Essentially, the EVM acts as a “world computer” for performing software operations in a decentralized environment.

Devoid of centralized control, the EVM is sustained by several individuals/companies lending computing power to the system in exchange for incentives. Therefore, it is useful for creating censorship-resistant applications that cannot be unilaterally shut down by any party.

The EVM is Turing-complete, as it can be used to perform computations of varying complexity. This is what separates Ethereum from Bitcoin, as the latter is Turing-incomplete, limiting its functionality.

Bitcoin functions primarily as a "distributed ledger", which specifies rules for the transfer of value. In addition to handling the transfer of value, Ethereum (via the EVM) enables the deployment of smart contracts. As a result, Ethereum is described as a “distributed state machine.”

“State” refers to the information about a system at any point in time. In Ethereum, state refers to the addresses, account balances, and smart contract code existing at a specific moment. Each transaction causes a change in Ethereum's state (state transition) that's reflected throughout the network.

[Image source]

How Does the Ethereum Virtual Machine Work?

Here, we'll explore the basic building blocks of the Ethereum Virtual Machine. This is to provide a basic overview of the system, so some heavy technical details may be left out.

Opcodes

The EVM uses a series of instructions called "opcodes" to execute different tasks. There are 140+ opcodes enabling the execution of different processes in the EVM—hence, Ethereum's description as Turing-complete.

We need opcodes because the EVM cannot interpret instructions written in Solidity, the language used for coding smart contracts. Ergo, smart contract code are converted to opcodes, so they can be executed in the EVM environment.

For example, you can create a smart contract using the CREATE opcode or halt a running contract with the STOP opcode. You can check here for a detailed overview of opcodes in Ethereum.

Gas

Gas is the resource that enables the execution of code in the EVM environment, measured in wei (a unit of ether). Just like you need gas to power your car in real life, the EVM needs gas to execute operations.

Earlier, we mentioned "opcodes"—specific instructions that can be used to perform different operations in the EVM. Gas is simply the amount of computational resources required to perform a particular operation.

Every code execution carries a gas fee, which varies depending on many factors, such as the complexity of the operation and network-wide demand. Gas fees incentivize individuals to lend their computing power to Ethereum. Without gas fees, the EVM wouldn't function as a decentralized computer.

Gas serves another purpose: preventing the execution of malicious actions, like distributed denial-of-service (DDoS) attacks. While the EVM can run almost any computation, it's hard to predict the runtime for every operation.

A well-designed malicious operation can run infinitely, causing the network to lose scarce computing power and eventually crash. Gas fees prevent this problem by forcing malicious actors to pay for every step performed in the computational process.

Before initiating an operation, you must specify a “gas limit”—the maximum amount of gas you're willing to spend on a computation. Once the gas limit is exceeded, the computation halts immediately. Again, this stops anyone from deploying “infinite loop” computations that could threaten the health of Ethereum.

An overview of some gas fees in Ethereum. [image source]

Smart Contracts

Smart contracts are pieces of code that execute once a predefined set of parameters are met. A smart contract uses conditional programming (if y, then x) to perform operations.

Smart contracts are immutable, autonomous, and transparent. These features combined make smart contracts particularly appealing, although they are not without flaws.

'Immutability' means a smart contract's code cannot be altered once deployed on the blockchain. Smart contracts are autonomous because they can self-execute without external control. And they are transparent since the rules governing their performance are written in publicly available code.

Some smart contracts are used to create and exchange tokens on the blockchain. ERC-20 tokens, for instance, have a smart contract defining their naming, creation, exchange, total supply, and other attributes.

[Image source]

Transactions

A transaction is an instruction from an Ethereum account. An example transaction is sending ether to an address from your wallet. Here, you're instructing the EVM to transfer value from your wallet to another location on the blockchain.

Not every transaction on Ethereum involves the transfer of value; some may transfer arbitrary data. The result of a transaction further depends on the recipient.

A regular, externally owned account (EOA) will simply receive the ether sent. However, a contract account may execute code once the transaction is successful. And, as explained earlier, transactions result in a ‘state transition function’, i.e., a change in Ethereum's state.

[Image source]

These elements make up the core of the EVM's infrastructure.

Features of Ethereum Virtual Machine

Deterministic

In programming, determinism is the ability of a program to produce the same output for a specific input at every instance. Determinism ensures that developers can design programs to perform specific operations and produce required results, independently.

The EVM is deterministic, so opcodes provide the same results no matter how many times the computation is performed. This is important as Ethereum's smart contract-powered dApps handle high-value transactions and must perform reliably. Or else, users wouldn't be confident to use them without expecting failures.

Isolated

The EVM is isolated, meaning the code has no access to the processes on your computer. You can safely deploy programs in the EVM while protecting your hardware/software from potential problems.

Moreover, smart contracts operate in isolated environments within the EVM. Thus, bugs or hacks that affect a particular smart contract are kept from harming the underlying protocol.

Terminable

The EVM is Turing-complete, so it can theoretically be used to perform any computation if it has the right resources and instructions. However, every computation relies on the gas allocated to it. If the gas runs out, then the operation ceases to run.

In this context, you can see Ethereum as “quasi-Turing complete” or “terminable” since code execution can terminate at specific times. However, this feature is important to ensure programs don't run forever (accidentally or maliciously) and stall the network.

Why is the Ethereum Virtual Machine (EVM) Important?

The Ethereum Virtual Machine is what makes the execution of smart contracts on the Ethereum protocol possible. These smart contracts underpin decentralized applications, tokens, and many of the projects running on the Ethereum blockchain.

Here is a detailed overview of the EVM's functions:

1. Providing a runtime environment for smart contracts

Without the EVM, deploying a smart contract would be futile. The EVM provides a safe, sandboxed environment for the execution of smart contract code.

2. Functioning as a decentralized processing unit

The EVM powers the Ethereum protocol and gives it the programmability necessary to create decentralized applications (dApps) Every transaction or smart contract execution is performed in the EVM.

3. Keeping track of state changes

The EVM monitors changes to Ethereum’s world state. As explained earlier in this article, state in Ethereum-speak refers to a description of the Ethereum protocol at any point in time. Ethereum's state comprises account balances, contract code, contract storage, and more.

Operations, like sending ether, executing code, or creating a contract, ause changes in state. And it is the EVM's job to update the Ethereum network state to reflect those changes.

Final Thoughts

The Ethereum Virtual Machine is at the heart of Ethereum's operation. Without the EVM, Ethereum cannot become an “Internet computer, powering decentralized applications available to users around the world.

However, the EVM still faces many problems, such as poor scalability, that limit its functionality. But planned upgrades to Ethereum, including sharding, promise to improve the EVM and expand its usage

Cover photo by Choong Deng Xiang on Unsplash.

Bitcoin’s low transaction speed discourages institutional investors, especially those involved in cryptocurrency arbitrage. Retail buyers may also find the lengthy transaction confirmation times off-putting since it harms liquidity and user experience.

The transparent nature of Bitcoin further causes problems for large-scale buyers. Anyone can see address balances and amounts involved in Bitcoin transactions. This puts large orders at risk of front-running and creates privacy concerns for institutional buyers.

Several solutions have been proposed to solve these problems—namely layer-1 and layer-2 solutions.

Layer-1 solutions require rewriting the blockchain protocol to implement changes, such as bigger block sizes or faster block times. While bigger block sizes and faster block times may increase transaction speeds, they tend to affect network decentralization and security. This is why the Bitcoin community rejected the SegWit2X proposal, leading to the hard fork that created Bitcoin Cash.

Layer-2 solutions, however, operate on top of the main blockchain without rewriting the network protocol. Layer-2 networks handle transactions off the main chain—hence, they are also known as “off-chain” solutions. To preserve the security and immutability of transactions, transfers executed off-chain are bundled together and added to the main chain.

Popular examples of layer-2 solutions developed for the Bitcoin blockchain include Rootstock, Lighting Network, and the Liquid Network. This article focuses on the Liquid Network and its implications for the Bitcoin ecosystem.

What Is The Liquid Network?

The Liquid Network is a sidechain built on the Bitcoin blockchain. Sidechains are layer-2 networks that interact with the main chain via a “two-way peg.” Assets on a sidechain are pegged 1:1 to the value of the native assets they represent, allowing anyone to use their tokens and coins on another blockchain.

[Image source]

The Liquid Network is designed to enable fast, private, and secure issuance, transfer, and exchange of cryptocurrencies, stablecoins, digital assets, and security tokens on the Bitcoin blockchain. While Liquid Network operates atop Bitcoin’s base layer, it operates independently and uses different methods to achieve higher throughput and more confidential transactions.

Liquid Network primarily serves institutional investors, exchanges, cryptocurrency traders, and other enterprise clients who desire a higher level of privacy and faster transactions. Retail investors cannot directly use the Liquid Network, except they go through a member of the Liquid Network.

How Does Liquid Network Work?

Essentially, what Liquid Network does is issue a “wrapped” version of BTC called L-BTC that can be used on its chain. To use Liquid Network, users initiate a “peg-in”, which involves sending BTC to a Lightning Network address on the Bitcoin blockchain. Once the transaction receives 102 confirmations, an equal amount of L-BTC is minted on the Liquid Network and sent to the user’s address.

L-BTC owners are free to use this tokenized BTC however they want on the Liquid Network. They may use it to trade on a Liquid-compatible exchange or buy assets and digital collectibles issued on the chain.

If a user wishes to withdraw their BTC, they initiate a “peg-out”, which starts with sending L-BTC to an unretrievable address for burning. Once this transaction receives two separate confirmations, a Lightning Network member sends the original BTC to the user’s address on the Bitcoin blockchain.

[Image source]

Unlike Bitcoin, Liquid Network uses a different method for generating new blocks. Transactions are bundled together into blocks and signed by the 15 Liquid Network Functionaries. These Functionaries run full nodes and are responsible for validating new transactions and broadcasting new blocks on the chain.

Additionally, Liquid uses Confidential Transactions to increase the privacy of Bitcoin transactions. This feature hides key transaction details, such as the amount transferred, the number of parties involved, and the balances left in users' addresses. However, network validators can still validate transaction amounts, total supply, and wallet balances.

Advantages of Using Liquid Network

Faster Transactions

Liquid Network uses Signed Blocks, which cut down the time it takes to validate and process transactions. New blocks are confirmed in around two minutes, unlike the 10 minutes it takes to add a block to the Bitcoin blockchain.

Liquid's faster transactions make it an ideal choice for arbitrage traders who need to perform cross-exchange trades quickly to make profits. With its long confirmation time, Bitcoin is ill-suited to the needs of such people, as trading advantages can be lost in mere minutes.

Retail investors who want faster transactions without converting their BTC to risky altcoins can transact using L-BTC on supported exchanges. This means they can make transfers and buy assets without delays and still enjoy the security of the Bitcoin blockchain.

Greater Privacy

Satoshi Nakamoto, Bitcoin’s inventor, designed Bitcoin as a public ledger of sorts. This improves transparency since anyone can map transactions to individual addresses and even check wallet balances.

However, Bitcoin’s transparency can cause headaches, especially for entities conducting large-scale transactions. For example, a third party can use information gleaned from analyzing transactions to gain a market advantage, called frontrunning. Frontrunning is disadvantageous to investors and discourages them from adopting Bitcoin.

Liquid Network implements Confidential Transactions to conceal key transaction information from outsiders. As such, only the sending address, receiving address, and transaction fee are recorded on-chain for transparency. The remaining details, such as the asset type and amount, are visible only to the parties involved in the transaction.

[Image source]

Reduced Transaction Fees

A hidden benefit of Liquid’s higher throughput is the lower fees paid on transactions. When the Bitcoin network gets clogged with unconfirmed transactions, miners will charge higher fees to prioritize some transactions. This has caused Bitcoin transaction fees to spike in the past, especially during bull runs.

Liquid’s novel consensus mechanism (block signing) increases transaction speed, so users don’t have to pay extra to process transactions quickly. Low Liquid Network fees are ideal for retail and institutional investors wanting to trade BTC without using other blockchains. While new-generation chains may promise lower transaction fees, they cannot offer Bitcoin’s security and liquidity.

Trustless Atomic Swaps

Atomic swaps provide a way for people to swap cryptocurrencies without relying on an exchange or another trusted intermediary. Liquid users can conduct trustless, peer-to-peer Atomic Swaps using the open-source Liquid Swap tool.

For example, users can exchange tokenized versions of BTC (L-BTC) and USDT (L-USDT) on the Liquid Network. This can create more liquidity for entities and make it easier to trade BTC for other assets.

Issuance of Assets

Liquid Network facilitates the issuance of digital assets, which would be impossible to do on Bitcoin, given the latter’s limited functionality. Users can issue, buy, and exchange the following assets on Liquid: utility tokens, security tokens, stablecoins, and digital collectibles (NFTs).

Limitations of the Liquid Network

The Liquid Network runs a federated system, where 15 Functionaries are responsible for adding new transactions and maintaining the ledger. While this system reduces confirmation time, it is highly centralized and subject to the control of a few parties.

Other concerns relate to Liquid’s single points of failure. Bitcoin is difficult to shut down or hack because there are thousands of nodes (computers) sustaining the network. Liquid relies on just 15 computer hubs, which increases the risk of censorship and malicious attacks.

Liquid Network vs Lightning Network

Like Liquid, Lightning Network is a layer-2 network operating on top of the Bitcoin blockchain. However, these off-chain solutions have different goals. While Lightning enables Bitcoin micropayments, Liquid focuses on transactions involving large amounts of Bitcoin.

Lightning and Liquid also have different target users. Small businesses have found Lightning Network’s payment channels incredibly useful for processing Bitcoin payments. Conversely, enterprises, such as financial institutions and cryptocurrency exchanges use Liquid to execute private and faster transactions.

Who Controls the Liquid Network?

Liquid Network is the brainchild of Blockstream, a blockchain solutions company headed by Adam Back. Back developed Hashcash, which inspired Bitcoin’s proof-of-work consensus, and was one of the few people Satoshi Nakamoto contacted while working on Bitcoin.

While Blockstream created Liquid, the network is run by the Liquid Network Federation. The Liquid Federation comprises 15 validators (“Functionaries”); regular members who can vote on network updates; and nodes that verify the state of the network.

While anyone can run a Liquid node and monitor the network, only the 15 Functionaries running full nodes can create new blocks. This position is regularly rotated among Federation members to achieve some measure of decentralization.

Any Liquid Network Federation member (not necessarily a Functionary) can process peg-in and peg-out transactions (converting BTC to L-BTC). This requires that Federations keep pre-funded wallets on both Bitcoin and Liquid, so users can receive their wrapped or unwrapped assets quickly.

[Image source]

Final Thoughts

The Liquid Network has emerged as a popular solution for scaling the Bitcoin network and adapting it to enterprise needs. Liquid improves Bitcoin without modifying the underlying protocol and affords users extra functionality without sacrificing security.

Liquid also introduces programmable functionality, tokenization, and interoperability to Bitcoin. This may strengthen it against Ethereum, Solana, Cardano, and other newer rivals and preserve its status as the world’s leading blockchai

But there’s another blockchain use-case that’s (probably) more important than you think: decentralized storage.

The decentralized storage model protects the integrity, accessibility, and security of data by spreading the hosting of files across a peer-to-peer network. Centralized storage systems hold your data in large servers, but this can incur the risk of censorship, data loss, or information theft.

In this article, we explore how decentralized storage works and what benefits it offers. The article also gives a brief overview of popular decentralized storage projects.

What is Decentralized Storage?

Decentralized storage applications store data on a distributed network run by computers scattered across multiple locations. Nodes collectively store and secure data and are responsible for making files available to owners. For their efforts, nodes on a decentralized storage network are given incentives in form of tokens paid by users.

As is evident, decentralized storage solutions are free from control by a single entity. Instead, peer-to-peer (p2p) nodes sustain the network and keep it operational. Without centralized management, data storages eliminate single points of failure and reduce counterparty risk for users.

How Does Decentralized Storage Work?

Using centralized cloud storage requires uploading your file via the Internet to a server. And if you need it, you send a request to the same server.

Decentralized cloud storage uses a different mechanism for storing data. You still have to upload the data, and can request for it anytime, but how that data gets stored is significantly different from a centralized solution.

Encryption

Data uploaded to a decentralized storage network is automatically encrypted using cryptographic hash mechanisms. Your private key gives you access to the data and prevents non-authorized entities from decrypting the information.

Sharding

Files are split into little pieces and sent to different nodes on the network. Sharding ensures no single node holds the complete dataset, eliminating the problems of censorship and privacy intrusion. With bits of your data spread across the network, no one can read your information or restrict access.

Storage

Finally, the sharded bits of your file are sent to several nodes located in different geographical areas. If you need the file, the network retrieves the components from nodes storing it and reassembles it for you to download.

[Image source]

The Benefits of Decentralized Storage Networks

In 2006, British mathematician Clive Humby described data as "the new oil." The prescience of this statement is apparent later, as the growth of eCommerce, Web applications, and IoT/AI have spurred the creation of large amounts of data.

To extract value from data, enterprises invest considerable amounts into data storage and management. A company might decide to build bespoke data centers or rely on cloud storage services provided by Google Drive, DropBox, and Amazon Web Services (AWS).

However, centralized storage of information presents teething problems. Large databases are susceptible to malicious attacks, with hacks resulting in losses every year. And because the information is stored in an external server, owners lose control—they cannot access it if the service provider goes offline or restricts access.

These are just some of the problems that decentralized storage networks were designed to solve. By sharing storage responsibilities among different participants, decentralized storage services provide a robust and secure method of storing information.

Data Security

In today's digital economy, data security is more important than ever. Poor data storage systems often lead to data breaches, identity theft and other problems, which are costly for both companies and users.

Centralized storage services promised to fix data storage problems, but have failed to live up to this promise. For example, a hack on Dropbox—one of the world's largest cloud storage companies—led to 68 million passwords getting leaked on the dark web.

Decentralized, peer-to-peer networks are theoretically safer compared to their centralized networks. That's what makes them ideal for protecting important data from malicious actors.

To attack a decentralized storage service, hackers need to access every node running the protocol. The enormous costs required to pull off this exploit are often enough to discourage hackers from trying to steal your information.

[Image source]

Privacy

If it wasn't obvious already, storing sensitive information on a company's server breeds privacy violations of immense proportions. Even if the company encrypts information, the encryption key is still stored on a server. Savvy hackers can steal the encryption keys and access your private information.

Decentralized storage fixes this problem. Data files are split into different bits to protect them from unauthorized viewing. To recreate the file, these bits must be assembled—which is impossible to do without a private key or appropriate permissions.

Efficiency

On the surface, centralized cloud storage seems efficient. You can easily retrieve files from your Google Drive or Dropbox folder by logging into your account. But a closer look reveals the potential inefficiencies with such centralized data storage and management.

Your information is stored in a handful of data centers around the world. If these systems get knocked offline for any reason, accessing information becomes impossible. A distributed denial-of-service (DDoS) attack is enough to crash seemingly robust networks and block users from using centralized servers.

Since data centers may be clustered in certain areas, users in far-flung corners of the world may find it difficult to retrieve information. They may need to expend more bandwidth just to download information stored on a cloud storage platform.

Decentralized storage services operate on a robust p2p architecture where multiple nodes distributed across different locations hold copies of a file. Even if a few nodes go offline, your information would still be available. These systems are fault-tolerant, so a few nodes malfunctioning cannot affect their operation.

Blockchain-powered storage can theoretically reduce bandwidth usage. The servers storing your files are distributed across the world, and there's the possibility of finding a server close to your region. This makes downloading files easier and shrinks bandwidth usage.

Data Integrity

Data integrity is a concept that refers to the ability of data to retain its qualities throughout an entire lifecycle. In other words, files should remain accessible in their original form five, ten, twenty years from now.

Data integrity is difficult to implement with centralized storage systems. This is mainly because traditional storage applies a location-specific approach to storing information.

Say you need to access a particular webpage on this site. You could get it by putting a link to the file path in your browser. Here’s what that link could look like:

https://businesstechguides.co/series/blockchain

This link points to where the webpage (i.e., the file) is hosted. When you enter the link on a search engine, you’re requesting the data from whatever server (computer) holds it. If the file is in its original location, you should get the webpage.

But what if something happens to the particular server holding the file or the webpage itself gets moved to another location? The data simply becomes unavailable. If you’ve ever encountered a “dead link” (Error 404), it’s because the content you requested no longer exists in that location.

To remedy the problem of data persistence and integrity, decentralized storage systems use a content-specific approach. This method identifies data by its content, not the location. Here’s a link to a webpage stored on the InterPlanetary File System (more on this later):

https://ipfs.io/ipfs/QmWATWQ7fVPP2EFGu71UkfnqhYXDYH566qy47CnJDgvs8u

You’ll notice that this link has a long alphanumeric string. That alphanumeric string is called a hash, and hashes are unique to every piece of content. In other words, no two piece of content can have the same hash.

Thus, hashes serve as unique identifiers for data—and we can use them to find information on a decentralized storage network like IPFS. When you enter this link, you’re not asking to be taken to the specific place where the webpage exists. Instead, you’re asking anyone on the network who has a version of the webpage to make it available.

Because hashes are unique to content, it is impossible for anyone to pass off a fake file as genuine. Altering the content would also alter the hash, so you’d end up with a different-looking link from the original. Here’s a link to an altered version of the IPFS webpage included earlier:

https://ipfs.io/ipfs/QmP8CvqzGRgH3WyeVKm8F1Pr6S4PGfuaCx6NVWuc929HWf

Notice how the links are different? With decentralized storage, we can make sure data remains accessible forever and remains intact.

Lower Costs

Cloud storage companies have to create purpose-built facilities to store information. And running data centers also incurs additional overhead costs, which companies pass on to users in form of higher storage costs.

Decentralized storage options are cheaper because they don't require extensive overhead costs. People are incentivized to lend out unused device storage. Which means users can pay lower fees to store their data.

An Overview of Decentralized Storage Networks

While decentralized storage is a growing sector, the industry has seen the influx of new entrants promising different benefits. Here are a few decentralized storage networks available today:

InterPlanetary File System (IPFS)

[Image source]

Created by Protocol Labs, InterPlanetary File System (IPFS) is a decentralized protocol for storing and accessing data, like files, websites, and applications. IPFS uses content addressing to preserve the integrity of data and ensures long-term data persistence and immutability.

Filecoin

[Image source]

Filecoin is a blockchain running atop IPFS. While you can upload your data to IPFS for storage, there's no incentive for nodes to keep it around forever. Filecoin ensures your content will always be available by rewarding nodes (called miners) for storing it.

These rewards come from the transaction fees you pay to have the Filecoin network store your information. Filecoin has a proof-of-storage mechanism for verifying that miners store information as requested.

Storj

[Image source]

Storj is a decentralized file-hosting protocol running on the Ethereum blockchain. Nodes running the Storj software sell their hardware space and bandwidth to earn $STORJ tokens.

The Storj network encrypts and fragments files before storing them on a distributed network of nodes. With multiple nodes operating the network, Storj is immune to censorship, data loss, malicious attacks, and service failures.

Arweave

[Image source]

Arweave is another decentralized storage network aiming to dethrone traditional cloud storage providers like Google. It allows anyone with extra space to connect their computers (nodes) to the network and store data on behalf of others.

Those who sell storage space on the Arweave Network get paid in the network's native $AR cryptocurrency. This creates an incentive for them to keep those files available for clients. Arweave believes this incentive structure can help create a modern-day Library of Alexandria, which can preserve human information forever.

Final Thoughts

Centralized storage services may have worked for years, but their failings are becoming apparent. Decentralized storage networks running on the blockchain offer a better, cheaper, and more secure mechanism for storing information.

While decentralized storage networks are still in the early growth phase, their use is already picking up. And as demands for efficient data storage spikes, we can expect decentralized storage models to become indispensable for users and enterprises

The growth of blockchain bridges has a lot to do with growing adoption of decentralized finance (DeFi). Bridges allow users to seamlessly transfer assets between blockchains, increasing liquidity and the ability to leverage tokens for DeFi-related activities.

But there’s growing concern over widespread use of cross-chain bridges, particularly due to the risks they pose to users. With hacks on blockchain bridges costing users millions, the functionality of blockchain bridges is a topic that deserves analysis.

In this article, we’ll explore how cross-chain bridges work and what they offer. We’ll also consider examples of blockchain bridges and examine the risks of using cross-chain bridges.

What is a Cross-Chain Bridge?

A cross-chain bridge is a protocol that allows different blockchains “talk” with each other. Bridges connect separate blockchains, enabling users to transfer assets, tokens, smart contract information, and other forms of data across platforms.

Interoperability—the ability for different systems to communicate—wasn’t a consideration in the early days of blockchain technology. For example, Bitcoin and Ethereum existed as independent systems, so you couldn’t possibly spend BTC on Ethereum or ETH on Bitcoin.

This contrasts with the legacy financial systems, which operate an interoperable infrastructure. You could swipe your Visa credit card at any point-of-sale system anywhere in the world, without worrying if it supports Visa or not. Spending BTC on Ethereum required going through exchanges, a long, expensive, and risky process.

Cross-chain bridges solved the problem by making it possible to use assets on different blockchains without going off-chain. Note that your BTC doesn’t magically become ETH on Ethereum. Rather the cross-chain bridge enables asset conversion using a lock-mint-burn mechanism, which is explained in the next section.

How Do Cross-Chain Bridges Work?

Moving your BTC to Ethereum starts with sending an amount to a specified address on the source blockchain (Bitcoin). This information is relayed to the bridge, triggering the creation of an equal amount of tokens on the other blockchain.

Withdrawing your locked tokens follows the same process. You send the tokens to an address on the non-native blockchain, while your original deposit on the first blockchain is sent to your address.

Here’s an illustration to help you understand:

Suppose you have BTC but need ETH to participate in a DeFi staking program. So, you send 20 bitcoins to the bridge’s address on the Bitcoin blockchain. Once there’s proof of your deposit someone, called a “guardian”, mints 20 “wrapped” bitcoins (wBTC) on the Ethereum blockchain. These newly minted tokens are compatible with Ethereum, so you can use them however you like.

If you want to withdraw your locked BTC, you’ll need to send the wBTC to an address on Ethereum for burning. Later, the guardian unlocks the bitcoins you sent earlier and deposits them in your address on the Bitcoin blockchain.

Popular bridges include:

• Binance Chain Bridge
• Terra Bridge
• Anyswap
• Arbitrum Bridge
• Polygon Bridge
• xDAI
• Immutable-X
• Optimism

Classifications of blockchain bridges. Source: Medium

Benefits of Cross-Chain Bridges

Cross-chain bridges are popular for helping users move assets between separate blockchains seamlessly. As DeFi continues to boom, cross-chain bridges open up the ecosystem to more individuals. As seen in our previous example, users can convert assets quickly to take advantage of different earning mechanisms like yield farming, staking, and lending.

Cross-chain bridges are also useful for more than just asset transfers, however. With greater interoperability between blockchains, users can switch between platforms to enjoy unique benefits like faster transactions or lower costs.

For example, you can switch from a layer-1 network (Ethereum) to a layer-2 network (Polygon) to leverage the latter’s higher throughput and cheap gas fees. Not only does this improve user experience, but it also makes it easier for you to execute blockchain transactions.

Cross-chain bridges make it easier to use a decentralized application (dApp) across different blockchains.

Sometimes, using a particular dApp, such as Aave, on its native blockchain (Ethereum) can be problematic, especially if the network is congested. In this case, using the dApp (Aave) on a faster layer-2 network like Polygon may be better. With a bridge, you can convert to your ETH to MATIC tokens and start using Aave on Polygon.

What are the Risks of Using Cross-Chain Bridges?

That blockchain bridges are revolutionary cannot be denied. However, their design often leaves room for vulnerabilities, which can be exploited at the expense of users. Below is an overview of major problems with cross-chain bridges today:

Single Points of Failure/Centralization

Cross-chain bridges vary by design. Centralized bridges rely on one administrator or a small group of entities to manage the minting and burning of tokens. In this case, there’d be one party or a set of trusted individuals (often called “guardians’) responsible for the following function:

• Holding of assets deposited on the source blockchain
• Notifying the bridge of the transaction
• Verifying proofs of transaction
• Minting and burning wrapped tokens

Binance Bridge, managed by the Binance Company, is an example of a highly centralized bridge. With this bridge, users can transfer Binance Coin (BNB) to Binance Chain, Binance Smart Chain, and other blockchains, with Binance managing the entire process.

A slightly centralized bridge, such as Chainswap, uses a group of trusted relayers. Here, the functions are distributed, so any relayer can execute the minting and burning actions on either blockchain. These relayers must stake some tokens before getting approval, and this stake can be slashed if they are guilty of malicious activity.

Centralization creates risks for users, forcing them to trust a company in Binance Bridge’s case or a group of unknown validators in Chainswap’s case. Some would argue that this isn’t a problem: Binance, a reputable company, cannot possibly steal user funds, and platforms like Chainswap have Know-Your-Customer (KYC) requirements for prospective validators.

However, trust counts for little when large amounts of assets. It’s all too easy for a hacker or even malicious insiders to breach a central node or permissioned network and take over the blockchain bridge to steal client funds or mint new tokens without deposits. And there’s the problem of custodians losing their private keys, rendering funds irrecoverable.

Poor Liquidity

Cross-chain bridges have appeal because they provide customers with much-needed liquidity. A user can easily swap unused ETH and convert to BNB for any reason—processing transactions, buying assets, or trading. A bridge breaks down crypto’s walled gardens and permits value to flow between different blockchains.

But not every cross-chain bridge fulfills the vaunted promise of liquidity. To be truly liquid, a bridge must have asset pools on both the native and non-native blockchains to make the lock-mint-burn-release process faster and easier.

Centralized bridges have higher liquidity since the controlling entity has incentives to keep asset pools on multiple platforms. This feat is harder to replicate with decentralized bridges since users have lower incentives to keep funds locked on different blockchains. As a result, users may find swapping assets difficult, negating the usefulness of a bridge.

Technical Vulnerabilities

To reduce reliance on trusted intermediaries, decentralized bridges use smart contracts to manage asset swaps. Users deposit funds in a smart contract, which automatically initiates the minting of wrapped tokens on the other blockchain.

Then users can call the contract’s “burn” function, which burns the tokenized assets and releases the original assets. The entire process is coordinated trustlessly by the smart contract, reducing third-party risk.

However, smart contracts have many flaws—for example, they are as secure as developers make them. Many cross-chain bridges rely on the soundness of the smart contract code, not the security of the blockchain. As such, bridges using poorly written smart contracts are vulnerable to malicious exploits, which presents an even bigger risk for users.

The $320 million hack on Wormhole (a Solana-Ethereum bridge) exploited a flaw in the smart contract code that allowed the hacker to mint 120,000 wrapped ether (wETH) on Solana without depositing any ETH tokens. In another exploit—this time on Qubit Finance’s Ethereum-BSC bridge—hackers were able to mint 206809 Binance (BNB) coins worth $80 million on the BSC chain without depositing any ETH.

Deficient smart contracts present a greater attack risk vector for cross-chain bridges due to the blockchain’s immutable nature. In fact, some bridges hacked have resorted to begging hackers to return stolen funds. That’s worked in the past, but counting on unscrupulous individuals to surrender their loot every time is like expecting to see cheese on the moon.

Risk of Censorship

Cryptocurrency’s raison d’etre is the provision of censorship-resistant money to people. Most public blockchains fulfill this promise as long your tokens live on their native networks. Once you start swapping an asset via bridges, you’re trading off censorship resistance for liquidity.

Let’s imagine you’re using a centralized or permissioned cross-chain bridge. You’ll need to trust the custodian(s) to burn your wrapped tokens and send the original coins to your address on the original blockchain.

But what happens when the “trusted” custodian(s) refuse to stop minting and burning tokens? Your funds will remain locked up forever—and that’s the end.

Final Thoughts

Cross-chain ridges have brought higher interoperability to the blockchain industry and created a better experience for blockchain users and developers. Still, interoperable blockchain platforms have problems to solve, including growing centralization, security risks, liquidity issues, and more.

With improvements to cross-chain bridge architecture, a future where interconnected blockchains form a giant interoperable ecosystem is possible. For now, we must accept that true—and secure—blockchain interoperability is far from being realized.

Cover photo courtesy of Cadalyst.com

Bitcoin worked because Satoshi Nakamoto brilliantly combined incentives that encouraged different parties to sustain the network's security, decentralization, and functionality.

Nakamoto's design inspired "cryptoeconomics", a concept that combines cryptography and economics to create a functional, decentralized peer-to-peer network to secure transactions.

Cryptoeconomics can be hard to grasp, but this article is an ELI5 introduction to the concept. We’ll consider cryptoeconomics in detail and explore its applications in real-world situations.

The Meaning of Cryptoeconomics

Cryptoeconomics is a portmanteau of “cryptography” and “economics.” As defined by the MIT Cryptoeconomics Lab, cryptoeconomics “brings together the fields of economics and computer science to study the decentralized marketplaces and applications that can be built by combining cryptography with economic incentives.”

Cryptoeconomics is how we design rules that incentivize participants in a distributed system to act honestly and secure the network. Cryptoeconomics is crucial in sustaining decentralized networks like public blockchains and preserving their unique qualities—security, immutability, and censorship resistance.

Many early peer-to-peer networks failed because participants had minimal incentives to sustain the network. Without any rewards for contributing to the p2p network, there was nothing to stop people from trying to attack or game the system.

Satoshi Nakamoto was the first person to devise a system of rewards and punishments to encourage honest behavior. Called “proof-of-work”, Bitcoin’s mechanism required computer nodes called “miners” to invest a valuable resource (electricity) before participating (i.e., adding new transactions to the blockchain).

Honest miners who added valid transactions received a “block reward”, which consisted of newly generated coins and transaction fees. Conversely, dishonest miners lost the block reward but also failed to recoup gains on their investment (electricity).

We’ll dive deeper into the cryptoeconomics of Bitcoin later, but the above summarizes the main goal of cryptoeconomics: incentivizing honest behavior and punishing malicious actors. For now, let’s look at the various components of cryptoeconomics.

Components of Cryptoeconomics

It’s easy to conclude cryptoeconomics is just another field of economics. However, while cryptoeconomics borrows from classical economic concepts like game theory, it adds several elements, making it an entirely new field.

This section covers several concepts that underpin cryptoeconomic protocols, especially those found in cryptocurrencies. It’s also important to note that cryptoeconomics applies to other cases aside from cryptocurrencies.

Game Theory

Game theory is the study of the interaction between rational agents in a system with clearly defined rules and rewards. The assumption is that individuals always protect their self-interest and follow strategies that benefit them. Therefore, the role of game theory is to predict the potential actions of individuals and evaluate the results of those actions on the system.

Mechanism Design

Mechanism design combines both economics and math to create systems that produce desired outcomes. If game theorists study how different players act in a game, then mechanism designers create the game itself.

In the context of cryptoeconomics, mechanism design guides the creation of functional blockchain networks. By understanding how participants may act, we create certain rules that ensure they act how we want, i.e., honestly.

Economic Incentives

Economic incentives refer to the system of rewards that influences the behavior of individuals. Cryptoeconomic protocols use economic incentives to control the actions of nodes in a distributed network.

Here's a brief illustration of economic incentives:

Jack works for XYZ Corp. as an accountant and receives a salary (along with other benefits) as compensation. Now, Jack could use his position to steal money from XYZ Corp, but he doesn't.

That Jack doesn't steal from the company doesn't make him a saint. Heck, Jack could be the greediest person to ever work as an accountant.

However, Jack cannot plausibly steal because of the consequences. Getting caught would cost Jack his job and lead to a loss of income. Jack's employer could sue—more money to be spent on lawyer fees—and put him in jail. Also, Jack will likely find it difficult to get a job after jail, since employers may be unwilling to hire an ex-convict to secure their funds.

The summary here is: Jack has incentives to remain honest regardless of his values. In the same way, blockchain protocols attempt to design economic incentives that promote positive actions among nodes in the network.

Token Engineering

The difference between Bitcoin and other peer-to-peer systems that came before it was the existence of a financial incentive for participation. This incentive was in the form of "tokens"—digital assets that have some value attached to them.

In Bitcoin's case, miners received a certain number of tokens (bitcoins) for validating transactions and securing the chain. Other decentralized networks adopted the same method: rewarding users with tokens for sustaining the system.

But the token itself must be designed to have value, or else it'd be worthless, reducing financial incentives for network participants. This is where token engineering comes in—we must program features into tokens that make them valuable.

Here's an example:

Imagine a city issues tokens that grant the holder access to the Metro Bus. This token has value because it allows you to travel within your city. It's also valuable because other people may want that token and will pay you to use it.

The value of the token also depends on supply and demand. Suppose more people want to use the Metro Bus, but not enough tokens to go around. People will be willing to pay higher amounts to secure the token, increasing its value.

Thus, the Transport Department may deliberately limit the introduction of new tokens to avoid crashing the value of existing units. Additionally, it may raise the requirements necessary to acquire one of the tokens—for example, requiring that holders must be six-figure earners.

Cryptoeconomic protocols may implement similar measures to program value into tokens. This includes designing them for specific uses, capping supply, and raising the bar for ownership.

For example, Bitcoin has value because it's useful for storing value (inflation hedge) and settling transactions (payments). Its value also derives from scarcity (on 21 million bitcoins will ever be mined) and acquisition costs (miners must invest in specialized hardware and electricity)

Cryptography

Cryptography plays a key role in securing peer-to-peer decentralized networks. On a blockchain, "cryptographic proofs" are necessary for validating information. Without cryptographic proofs, it'd be impossible to verify the truth of transactions and determine if nodes are acting honestly.

Two important cryptographic proofs used in Bitcoin are hashes and digital signatures. Let's look at both concepts in detail:

Hashes

A hash function runs an input of any size and returns an output of fixed size. Here's an example of a hash derived from running "emmanuel" through an SHA-256 hashing algorithm:

25eaebedfb6ad2b4701c34333231755afb593792844378aebf0117c9e3ef4402

A hash is a one-way function, meaning you cannot determine the input from the output. Using the above example, there's no way you can know the text ("emmanuel") encoded in the hash just by looking at it.

While hashes help protect the confidentiality of information, their usefulness lies in their ability to verify information on a decentralized network.

Because hashes are linked to their inputs, changing the information causes the hash value to change. If I change "emmanuel" to "emmanuelle", the resulting hash looks very different from the original:

fa14cf60ee743d478f76fb1c5ee8c5f3889d58f2b8636c1a11fbdf0ca7f2c863

So, how do hashes apply to the blockchain or, specifically, cryptoeconomics?

Nodes must hash each transaction in a block and, thereafter, combine these hashes into a single hash called the "root hash." This root hash derives from all transactions contained in a block and serves as a "digital fingerprint" for the block.

If the information within a block is altered, then the block's hash will change as well. That way, other nodes can easily notice the alteration attempt and reject the transaction block.

Another use-case for hashes, commonly associated with Bitcoin, is verifying if nodes have done the "work" necessary to add new transactions. Bitcoin requires miners to find a target hash before adding blocks to the chain. Since. finding this number is incredibly difficult, anyone who does automatically has "proof of work" and can broadcast new transactions on the blockchain.

Digital Signatures

Digital signatures are used to verify the source of information in a decentralized network. Without digital signatures, it'd be difficult to determine who initiated a transaction.

Digital signatures work through a public-private key generation protocol (PGP). When a new blockchain address is created, a "public key" is generated from the address, while the private key is derived from the public key.

Think of the public key as an "ID badge" that you can share to prove your identity. However, the private key is like a bank PIN used to authorize transactions. Like the bank PIN, your private key must be kept secret.

So, how do digital signatures apply to blockchains and cryptoeconomics?

Generating a digital signature requires "signing" a transaction with your private key. Public-private cryptography is structured such that anyone can verify your signature if they know your public key.

The basic rule of any blockchain is: transactions are only valid if signed with the correct private key. With this feature, nodes can easily validate transactions that other nodes submit for addition to the blockchain. Thus, any invalid transactions submitted will be rejected and the dishonest node penalized.

Cryptoeconomics in Action: The Bitcoin Example

As with all concepts, our understanding of cryptoeconomics might benefit from analyzing its real-world applications. Bitcoin was the first successful cryptoeconomic experiment and gave birth to cryptoeconomic research, so we’ll use it in our example:

Before miners can add new transactions, they must solve complex puzzles as “proof of work.” The Bitcoin protocol is pre-programmed to increase the difficulty of those puzzles, so miners must invest in powerful computers, such as Application Specific Information Computer Systems (ASICs).

By nature, ASICs cost a lot, consume huge amounts of electricity, and require specialized cooling options, as they produce considerable heat. If we add equipment costs, electricity costs, and cooling costs, it’s obvious miners are making a considerable investment.

To recoup their investment, miners must try to secure “block rewards” by adding valid transactions to the Bitcoin blockchain. Miners can then sell bitcoins earned through the block reward, take their profit, and reinvest the rest into mining operations. With the current block reward pegged at 6.25 BTC (around $237,000), miners have every incentive to follow the rules.

Bitcoin’s cryptoeconomic design further protects it from outside attacks. To control the Bitcoin consensus mechanism, malicious actors need to control more than 51 percent of the total computing power (hash rate) dedicated to the network. A successful 51 percent attack would allow malicious actors to reverse transactions, block new transactions, and potentially double-spend bitcoins.

However, the costly nature of mining means an attack on Bitcoin requires massive investments in electricity and hardware. An estimate suggests attackers would need to spend around $34 billion on hardware and $23 million on electricity every day.

Perhaps now we see why cryptoeconomics is crucial to Bitcoin’s security and functionality. Bitcoin wouldn’t exist as a decentralized, censorship-resistant, and secure payments network without Satoshi Nakamoto’s brilliant combination of cryptography and economic incentives.

The Value of Cryptoeconomics

Cryptoeconomics is useful in designing consensus protocols, which help nodes agree on the true state of the blockchain. Bitcoin’s proof-of-work is an excellent example, but other consensus algorithms like proof-of-stake apply a similar principle.

Let’s use Ethereum’s proof-of-stake system as an example. To add new transactions, nodes (“validators”) must lock some tokens (ether) into a smart contract. This is similar to Bitcoin’s PoW system which requires miners to commit resources, however, validators are committing money, not electricity.

Ethereum’s PoS protocol is designed to select validators randomly based on the size and age of their stakes. If a validator acts dishonestly, the funds in the smart contract are automatically frozen. Dishonest validators also lose the transaction fees paid out on each valid block.

We can also apply cryptoeconomics to designing secondary applications that run on the blockchain (decentralized applications). The underlying blockchain protocol developers create tokens necessary for economic incentives and smart contracts that power these applications.

An excellent example of an application powered by cryptoeconomics is Augur, a decentralized prediction market. Typically, users bet on certain outcomes and receive profits or gain losses depending on the outcome.

Augur relies on nodes (“reporters”) to feed it the information it uses to determine if a bet is successful or not—and this is where cryptoeconomics comes into the picture. Reporters stake tokens (REP) and earn rewards for reporting truthful outcomes. However, any attempt to report false information leads to a loss of staked tokens.

Decentralized Autonomous Organizations (DAOs) are another use-case for cryptoeconomics. In a DAO, a token allows the holder to contribute work and earn rewards for their participation. To earn greater rewards and increase participation, DAO members must buy more tokens, which is just another example of economic incentives in action.

Final Thoughts

Cryptoeconomics is essential for creating self-sustaining, secure, and useful decentralized networks. By creating incentives, it’s possible to bring together unaffiliated individuals to participate in a peer-to-peer system without a central entity enforcing rules of behavior.

More importantly, the long-term sustainability of a blockchain or blockchain-based project is linked to cryptoeconomics. Without a well-designed system of rewards and penalties, participants have no incentives to keep the network functional and secure.

Cover photo by Art Rachen on Unsplash

But then Facebook changed its name to “Meta” in late 2021, reflecting owner Mark Zuckerberg’s dream to “build the Metaverse.” Describing the metaverse as “a shared virtual world where [anyone] can socialize, work, play, and create,” Zuckerberg predicted it'd be the next iteration of the Internet, and committed Facebook’s (now Meta) future to creating it.

With one of the world’s biggest tech giants betting the farm on the metaverse, interest in the concept has skyrocketed. More importantly, businesses are looking for opportunities to tap into the metaverse and harness this technology for bigger profits.

In this article, we’ll explore the meaning of the metaverse and consider opportunities for businesses to leverage this new technology.

What is the Metaverse?

At its most basic, the metaverse is a collection of immersive, three-dimensional (3D) worlds that facilitate virtual interaction between individuals. In a metaverse, people can perform real-world activities—learning, creating, socializing, shopping—in cyberspace.

The metaverse runs on augmented reality (AR), virtual reality (VR), extended reality (XR), artificial intelligence, and spatial computing technologies. Individuals rely on devices, such as smartphones, laptops, IoT devices, and VR/AR products like Google’s Oculus VR headsets or Microsoft’s HoloLens to access the metaverse and interact with it.

Blockchain technology is also crucial to the metaverse. With non-fungible tokens (NFTs), anyone can create unique digital assets, such as avatar skins and accessories, that can be used in a virtual universe. Cryptocurrencies power the metaverse economy and allow users to pay for products or access certain services.

Futurists imagine the metaverse as a giant virtual world, where websites become gateways to virtual spaces. However, what exists currently is the "proto-verse": a group of independent virtual worlds with worlds with different users, access mechanisms, and monetization systems.

Realizing the metaverse dream will transform the Internet into a massive, interoperable virtual realm. Users can seamlessly switch between digital worlds, using their assets on different platforms. For example, an avatar skin bought in Fortnite would be usable on Decentraland.

Facebook announced its metaverse plans last year. Source: YouTube

Is the Metaverse Here?

Contrary to public expectation, the metaverse is far from becoming a full-fledged reality. Even Facebook has said it doesn’t expect the technology required to power the metaverse to arrive until the next 10-15 years.

However, we have some examples to show what a metaverse future may look like:

Roblox: Roblox is a gaming platform that allows users to create and play across virtual worlds. Creators can monetize their games by selling in-game assets to users through Robux, the platform’s virtual currency. This virtual currency can be converted to real money on the Roblox Developer Exchange (DevEx).

Virtual gaming platform Roblox has become a runaway hit. Source: Wired.com

Fortnite: Fortnite started life as a free-to-play multiplayer shooting game, quickly gaining popularity for its realistic gameplay. But it’s slowly transforming into a bigger virtual world, with rapper Travis Scott holding a virtual concert on the platform in April 2020.

Travis Scott’s “Astronomical” concert was held on Fortnite. Source: YouTube

Facebook Horizon and Microsoft Mesh: Facebook released Horizons Works, a virtual workspace, to compete with Zoom and Microsoft Teams. Using headsets from Facebook-owned Oculus VR, employees can interact, collaborate, and brainstorm without needing to meet physically.

Microsoft launched a competing product, Mesh, signaling the company’s interest in metaverse technology. Like Facebook’s Horizons, Microsoft Mesh can create “digital twins” of physical workspaces, enabling virtual interactions between coworkers.

Facebook plans to reimagine remote work with Horizon Workrooms. Source: about.fb.com

Decentraland and The Sandbox: Decentraland is a 3D virtual world where anyone can build digital structures, such as theme parks or art galleries, and charge visitors a fee. It runs on the Ethereum blockchain and allows users to buy digital assets as NFTs using its native token ($MANA).

The Sandbox is another gaming metaverse running on the Ethereum blockchain. Like Decentraland, Sandbox users can create and sell unique digital assets as NFTs. Purchases are made using the ecosystem’s native currency ($SAND).

Players can visit virtual parks in Decentraland. Source: Euronews.com

Second Life: Second Life is one of the oldest and most popular 3D virtual worlds. Launched by Linden Labs in 2003, Second Life lets individuals—represented by avatars—can carry out real-life activities in an immersive virtual world. Users can create, shop, socialize, and do much more in Second Life’s virtual spaces.

Why the Metaverse Matters for Businesses

While the metaverse is still in its infancy, dismissing it would be economic suicide for any business. Beyond tech giants like Microsoft and Facebook, other large brands have been making forays into the metaverse. For instance, fashion heavyweight Gucci launched a virtual gallery recently, while JP Morgan recently opened a building in Decentraland.

As an immersive virtual-reality world, the metaverse has a lot of business potential. Here are some benefits of the metaverse for business that every entrepreneur should consider:

Profits from Virtual Products

The virtual economy is booming. Sales of digital assets on virtual platforms like Decentraland, Fortnite, Roblox, and the Sandbox run into millions of dollars—representing a viable business opportunity. Brands can create virtual lookalikes of real-life products to metaverse residents and unlock new streams of revenue.

The list of companies already selling things in the metaverse is long. Earlier this year, Ralph Lauren launched a collection of wearables and has sold over 100,000 pieces already. Other luxury fashion houses, such as Gucci and Dolce & Gabbana, have also started creating virtual clothing lines.

Even sports apparel makers are getting in on the game. American sportswear giant Nike acquired RTKFT, a company noted for creating virtual products and has filed patents that’ll allow it to exclusively sell Nike-themed wearables, like Air Jordan sneakers, in the metaverse.

Smaller businesses can benefit from this trend, too. For example, a glasses manufacturer might offer buyers a pair as an NFT, while encouraging them to buy the real thing. As long as a product can be represented in virtual reality, there’s going to be a market for it.

Gucci “Virtual 25” shoes are created exclusively for AR worlds. Source: Deezen.com

Richer Customer Experiences

The introduction of eCommerce changed the way people shopped for products. However, customers are quickly outgrowing staid online shopping sites. They want an experiential buying experience where they can feel, see, and touch products before buying.

Companies can provide new ways for consumers to interact with products and services using augmented reality (AR) and virtual reality (VR) technologies. Instead of staring at static images, buyers can use products and see if they like the experience. If an individual feels good trying on virtual glasses, they’re more likely to buy the real product.

Some brands are already launching virtual malls, where anyone can come in and interact with branded items. Such innovations will greatly accelerate the buyer’s journey, reduce acquisition costs, and increase overall revenues.

Virtual malls may become the new shopping centers. Source: Datumcorp.com

Global Reach

Just as the Internet broke down geographical boundaries, the metaverse will do the same—but better. An ideal metaverse is a place where anyone can enter and interact with a brand, regardless of their location. For brands, the metaverse facilitates the creation of universally accessible experiences for customers across the world.

Often, global companies will launch different campaigns in various countries to compensate for distance. However, the metaverse world would allow a brand to house its campaigns in one place, which users from different regions can access at any time. It’s global expansion for a fraction of the cost!

Better Employee Engagement and Collaboration

Facebook’s demo of Horizons Workspaces has shown how virtual worlds can transform modern-day workplaces. In a post-COVID era, where remote work is becoming a norm, the metaverse can greatly enhance collaboration between employees.

Instead of staring at a Zoom screen for hours, individuals can collaborate, brainstorm, and discuss in a shared, virtual workspace. The metaverse will create an interactive environment where everyone, irrespective of their location, can connect with each other and share ideas.

For businesses, the use of metaverse in business communications can make collaboration, training employees, and organizing meetings easier.

A demonstration of Microsoft’s VR workplace. Source: YouTube.com

Improvements in Product Development

Many products fail to attract meaningful use due to poor product-market fit. While this can be corrected through product testing, current methods are costly and require extensive effort.

The metaverse can solve this problem for companies and ease product testing through the use of "digital twins." According to IBM, a digital twin is a complex, hyper-realistic virtual representation of a physical object.

Thanks to improvements in VR and AR technology, it’s possible to simulate real-life experiences in the metaverse. This means companies can have individuals test products under development and give useful feedback.

Several high-profile people, including NVIDIA CEO Jensen Huang, have backed the idea of VR-enabled product testing. And some companies, like Hyundai Motors, have made forays into the field already.

Using Roblox, the South Korean carmaker created Hyundai Mobility Adventure, a shared virtual space for people to try out its newest offerings. Visitors, represented by avatars, can test-drive new Hyundai models, robotic vehicles, and other transportation solutions.

Companies can also better understand how users interact with their products using VR-powered testing. By analyzing body language recordings obtained through VR simulations, businesses can gain deeper insights into customer behavior and apply the information to product development.

The wealth of data that can be obtained about consumers is staggering. For instance, a 2018 Stanford Review estimates that VR headsets can collect over two million body language recordings within a 20-minute timeframe.

Advertising Opportunities

Every technology brings with it novel techniques for getting products in front of customers. The Internet brought targeted advertising, while outdoor displays brought interactive billboards, drones, etc.

However, businesses need to avoid ruining the user experience with ads. As the public backlash against targeted advertising has shown, intrusive promotions can quickly sour consumer sentiment.

Instead, companies must invest in creating richer experiences and encourage users to participate. An excellent example of customer-centric marketing in the metaverse is Coca-Cola's Friendship Day campaign.

The beverage company auctioned a "Friendship Box" on OpenSea, which contained several NFTs. This included a themed bubble jacket that the owner could wear in Decentraland, a Friendship Card NFT featuring retro artwork, and a sound visualizer that played the sound of pouring a Coke. The winning bidder also received a real-life fridge stocked with Coca-Cola drinks.

Coca-Cola’s metaverse marketing is different from the in-your-face promotion that irritates consumers and affects marketing performance. As more companies enter the metaverse, those that invest in consumer-centric marketing will come out tops.

Coca-Cola's bubble jacket, auctioned as part of its NFT drop. Source: Forbes.com

How Can Businesses Enter the Metaverse?

It’s still early to know if the metaverse will become the latest technology revolution. Nonetheless, entrepreneurs can future-proof their businesses by preparing for a future where the lines between physical and virtual reality are indistinguishable.

Businesses can start their metaverse journey by identifying target demographics and understanding their preferences. Given the flurry of corporate forays into the metaverse, it's possible to borrow ideas from other brands and create a unique experience for a brand's user base.

Finally, as with every investment, understanding the risks of buying into the metaverse is important. There's no telling if the metaverse will take off or not, so caution is advised.

Cover photo by Julien Tromeur on Unsplash

Now, countries are planning to launch digital versions of their currencies, called central bank digital currencies (CBDCs). While the US is mulling a digital dollar, countries like China and the Bahamas have piloted CBDCs already. Even less-developed nations have gotten into the game.

If these signs are anything to go by, then CBDCs are inevitable. We're slowly accelerating towards a cashless society, and CBDCs will be the new pillars of the economy.

However, just because something is popular doesn't mean it's necessarily good—and this applies to CBDCs. While many have talked up the benefits of government-backed digital currencies, they leave out crucial information about how these new currencies will work.

And, as they say, the devil is in the details.

This article explores the meaning and implications of CBDCs while touching on the reasons for their popularity. I’ll also consider some of the risks of replacing fiat money with centralized digital currencies.

What are CBDCs?

A CBDC is a digital version of a country's currency that’s available for households and businesses to use for payments or storing value. CBDCs are created and issued by a country’s central bank, which is why they are called “Central Bank Digital Currencies.”

CBDCs are backed by the government and pegged to the value of the national currency. This makes a CBDC different from a cryptocurrency, which isn’t backed by any institution or asset. Since CBDCs have “legal tender” status, you can buy goods, pay for services, or settle your taxes with them—things you cannot do with crypto yet.

You can think of CBDCs as “stablecoins,” which are cryptocurrencies that derive value from a real-world asset like the dollar. Stablecoins like Tether (USDT) and Binance USD (BUSD) can be bought and redeemed like regular dollars and offer investors protection against crypto’s volatile price swings.

Like cryptocurrencies, CBDCs use Distributed Ledger Technology (DLT) to facilitate supply of money and transaction monitoring. Also, central banks may integrate permit payment services with the ledger to facilitate easier transactions.

An overview of the CBDC ecosystem. Source: Suerf.org

Why are CBDCs Getting Popular?

The shift towards a cashless society had been slowly happening, well before the COVID-19 pandemic. But, with lockdowns keeping people indoors, the demand for cashless, digital payments systems surged. And then Libra happened.

Before its demise, Libra was a cryptocurrency project floated by Mark Zuckerberg-owned Facebook. Unlike other cryptocurrency projects, Libra was the first visible effort by a private company to launch its own currency.

As expected, governments criticized the Libra project and pressured payments providers to withdraw support for Libra payments. While Libra eventually died quietly, it forced governments to see the threat of privately controlled currencies to state monopoly of financial systems.

Many world powers started taking the idea of virtual currencies seriously, and the Bahamas launched the world’s first CBDC (the Sand Dollar) in 2020. More countries have since followed suit, including China which introduced a “digital yuan” at this year’s Winter Olympics.

Facebook’s short-lived Libra project inspired CBDCs. Source: CNN.com

This timeline of events reveals the first and most important reason for the existence of CBDCs: increasing government control of money. There may be other reasons for using CBDCs, but that doesn’t change their status as tools of state monetary control.

Supporters of minting tokenized versions of state currencies claim they have other benefits.

For example, digital fiat-backed currencies can simplify payments for individuals and businesses. They’d also promote financial inclusion by allowing unbanked individuals to transact without enduring cumbersome registration processes.

CBDCs can ease the implementation of monetary policies—for example, destroying currency tokens in circulation would be enough to control inflation. Moreover, increased surveillance of money flows in an economy will prevent tax evasion, reduce corruption, and disrupt the funding of illicit activities, like drug trade or terrorism.

However, for all their benefits, CBDCs have many risks that are too serious to be ignored.

The Risks of Using CBDCs

Cryptocurrencies like Bitcoin (BTC) and Ether became popular because they are anonymous, censorship-resistant, secure, and decentralized. And no one can unilaterally determine the supply of bitcoin or ether, making them a hedge against inflation.

With CBDCs, the rules are different.

These “government-issued cryptocurrencies” belong to the government, and it can set rules for their circulation, use, and availability. Maybe you don’t realize it, but centralized control of digital currencies brings up many problems:

Encroachments on Privacy Rights

CBDCs will usher in unprecedented levels of spying on the privacy of citizens. Every purchase, every transfer, every payment can and will be logged in a government database for both benign (taxes) and non-benign (financial surveillance) reasons.

Governments will become Big Brother, tracking who is doing what with money in the country. If it wants, a government can easily block certain transactions it deems “illegal.” This could be anything from buying legal marijuana, paying a sex worker, or even remitting money to your family in blacklisted countries.

Cryptocurrencies provide the opportunity to transact directly with any party without anyone interfering. CBDCs threaten to turn this upside down and increase government oversight over monetary exchanges between individuals

CBDCs will give rise to “surveillance states.” Source: Expressvpn.com

Single Points of Failure

Most cryptocurrencies run on public blockchains sustained by distributed networks of computers (nodes). The decentralized nature of a public blockchain network allows it to keep operating even if a few nodes malfunction or suffer attacks.

Hacking a cryptocurrency requires controlling every node running on the network—a difficult, cost-ineffective, and impractical task. That’s why cryptocurrencies like Bitcoin and Ether have remained secure for years.

CBDCs will be fully centralized and hosted on private or permissioned blockchains. While these have better transaction speeds, they create single points of failure. Malicious actors only need to breach a few servers, and suddenly, they can control the entire country’s monetary supply.

Perhaps CBDC supporters have forgotten, but decentralization is the point of blockchain technology. A centralized digital currency exacerbates the very problems, like double-spending, which cryptocurrencies were designed to solve.

Distributed networks are more robust than centralized systems. Source: Merehead.com

Increase in Data Breaches

To achieve full functionality, CBDCs will likely expand on existing digital payment systems, such as Google Pay, Venmo, and Apple Pay. These apps will integrate into central bank deposits, allowing users to spend and send e-money via apps, chats, and messages.

Big Tech companies will become the new banking institutions, powering transactions all over the world. It’ll also allow service providers to collect your data and store it in centralized databases for corporate use.

Of course, there are downsides to companies harvesting personal data. For instance, companies are often criticized for leaking, selling, and mismanaging user information. Google is particularly notorious for selling user data to advertisers and fueling the ad targeting market.

This goes without saying, but centralized data storages are honeypots for malicious actors. Now, a hack on Google’s servers might probably lead to varying degrees of identity theft. In the future, hackers will steal your identity and your entire wallet balance.

Data centers are susceptible to malicious attacks. Source: Le-vpn.com

Unstable Monetary Policies

A purported benefit of CBDCs is that they make it easier to introduce and enforce fiscal policies. Governments can easily mint new currency tokens to counter deflationary trends in the economy. Tax offices will also find it easier to track money flows and deduct taxes automatically.

While all that sounds good in theory, it has several implications for financial stability.

Since central banks control the supply of CBDCs, inflation is a real risk. Heads of central banks, drunk on the Modern Monetary Theory (MMT) Kool-Aid, can simply press a button and inflate the circulating supply of digital currencies.

This will result in massive hyperinflation, where currencies become worthless and prices go through the roof. You think the runaway inflation in Venezuela and Zimbabwe was bad? Wait till your central bank starts minting currencies at a whim.

If CBDCs allow governments to enforce positive fiscal policies, then they can be used to enforce negative policies as well. Implementing negative interest rates on currency holders is certainly easier when you can program money however you like it. And that’s just one possibility; we don’t know other policies authorities will force citizens to accept through digital currencies.

CBDCs may lose their value to inflation. Source: Newsismybusiness.com

Financial Discrimination

A CBDC dramatically increases government control of cash flows in the economy. This may lead to the “weaponization of money,” where the government coerces individuals and businesses by cutting off their money supply.

Currently, political officials have to rely on third parties, such as banks and payments providers, to enforce financial discrimination policies. An example is the Nigerian government forcing banks to block donations to #EndSARS movements protesting police brutality.

With CBDCs, national governments can freeze monetary assets without leaning on banks. Criticized the ruling party or organized a protest? Too bad, ‘cause you’re about to get frozen out of the monetary system.

Already, countries like China have “social credit systems” that determine your access to certain services, based on your political views, shopping habits, online activity, work history, and other attributes. Pairing social credit systems with CBDCs means governments can “punish” those who contravene its rules by stopping them from spending money.

If that sounds like a dystopian nightmare to you, then you’re starting to see the risks of CBDCs.

Government can block businesses from selling semi-legal goods like marijuana. Source: NBCNews.com

Destabilization of Financial Institutions

So far, I’ve focused mainly on the problems CBDCs pose to individuals and businesses. But CBDCs are also problematic for banks and other large financial institutions.

The likeliest iteration of a CBDC system is one where the country’s central bank issues digital currencies directly to consumers and secures their deposits. Central banks would replace private banks, destroying the entire commercial banking system.

Even a hybrid approach that puts central banks and commercial banks in control of CBDC supply will still cause problems. Citizens may feel safer keeping their funds with the central bank than private banks, leading to recurring bank runs. What do you think will happen to the economy when every bank folds up?

What Does the Future Hold?

With around 80% of central banks exploring CBDCs, you can expect them to arrive sooner than you expect. And you’ll have no choice but to use them—how else are you going to pay for stuff in a cashless society?

The upside to introducing CBDCs is that the popularity of cryptocurrencies will increase. As people desire censorship-resistant money free of state control, the value of Bitcoin, Ether, and other cryptos will skyrocket.

Instead of killing crypto, CBDCs might just spark mass adoption of cryptocurrencies. To borrow Shakespeare’s famous expression: “All’s well that ends well.”

Cover Photo by Adam on Unsplash

Maybe you haven't thought about it, but the concept of blockchain-based social networks has been gaining steam for a while now. And for good reason.

While modern social networks have done a lot to enable human interaction, their infrastructure and operations leave much to be desired. Widespread censorship, arbitrary algorithm changes, privacy violations, intrusive ads, and undue exploitation of creators are some complaints leveled against legacy social networks.

Can blockchain technology correct the ills of centralized social networks? Well, many people think so. The idea is that blockchains can help create decentralized social media networks that are user-controlled, censorship-resistant, and private.

In this article, we look at decentralized social networks and their implications. We'll also consider challenges preventing We3 social media platforms from gaining mass adoption.

The Problem With Legacy Social Networks

When social platforms like Facebook, YouTube, and Twitter launched, they opened up new opportunities for human interaction. People could communicate across borders, exchange information, build communities, and distribute content seamlessly.

The revolutionary nature of social networks is evident in their astounding growth figures. Large social networks have billions of users combined—Facebook (2.91 billion), Twitter (290.5 million), and YouTube (2 billion).

Modern social networks wield enormous power in society. For instance, studies show that people are spending significant portions of their lives online. As such, social networks can significantly influence our views and behaviors through the content they feed us.

With great power, they say, comes great responsibility. However, social media companies have opted to prioritize profits ahead of user experience, safety, and wellbeing.

They implement algorithms that promote negative content to provoke user activity. They harvest user data and sell it to advertisers, who then populate our feeds with intrusive ads. They may even snoop on messages transferred between individuals.

But that's not all.

Social media companies earn huge profits from user-generated content but hoard a large percentage of this money. Worse, content creators can be de-platformed without warning, leading individuals to lose their means of livelihood.

Moreover, vague content moderation policies and centralized control have made it pretty easy for social media companies to arbitrarily censor users. This is why major platforms like Twitter and Facebook have been criticized heavily for a perceived attack on free speech rights and suppression of opinion.

The centralized storage of user data by social media networks is another problem worth noting. In recent years, we’ve seen hackers breach some of the world’s biggest platforms, stealing enormous amounts of personal information. Not only does this increase the risk of identity theft, but it also makes for an unsafe online experience.

Social networks have seen large data breaches in recent years. Source: Visualcapitalist.com

What Are Decentralized Social Networks?

Decentralized social networks are content creation and distribution platforms running on the blockchain. Many of these platforms attempt to correct the problems of Web2 social networks as highlighted in the previous section.

So, how might a Web3 social media application work? Thankfully, we have enough examples of blockchain-based social networks to show us how these platforms may change how we interact in the future.

Steemit, blockchain's answer to Medium, is a content curation platform that allows users to earn cryptocurrency based on the views their content gets. Readers can also tip content creators using the platform's native token ($STEEM).

A decentralized version of Twitter may make it impossible to delete or modify tweets. Once the information is live on the blockchain, no one—not even platform owners—can take it down.

This is how Peepeth, a Twitter-like service running on the Ethereum blockchain works. By design, posts (called "peeps") cannot be deleted or altered once published. Such solutions will likely reduce censorship and prevent the stifling of opinion rife on centralized social networks.

Web3 social networks may reward users for their time through watch-to-earn, learn-to-earn, play-to-earn, and other incentive programs. Some may even allow users to monetize their data and exchange it for crypto—as opposed to companies solely profiting from user data.

Some decentralized alternatives to popular social media apps. Source: Twitter.com

Why Blockchain Technology is Perfect for Social Media

There are many reasons people want a blockchain-based version of Twitter or LinkedIn. But what really makes the blockchain ideal for running social media applications?

Let's start with the basics. Blockchains are distributed across multiple computers in a peer-to-peer system that's difficult to shut down or hack. To take down a blockchain like Ethereum, you'd need to find a way to control thousands of nodes running the network.

With blockchain technology, we can build robust social applications that can run forever without interruptions. Dictators would be unable to censor public opinion by banning social media applications. Neither would server crashes stop billions of people from interacting like Facebook's crash did late last year.

We've already discussed the censorship-resistant nature of Web3 social media networks, but it bears mentioning again. Blockchain-based social networks are decentralized, meaning a small group of people cannot decide what can or cannot be said online.

Web3 social platforms would rely on decentralized identity, you wouldn't need to reveal sensitive information, like your email address or location, when creating a social media account. You'd only need to connect your digital wallet to prove your identity—and that's it.

Users won’t need to submit personal information for social media logins. Source: Coingeek.com

We could use blockchain-powered cryptography to encrypt messages, enabling secure and private peer-to-peer communication. No one would read messages between you and your buddies, so you'd feel safer sharing what you like in chats.

A discussion of the benefits of running social networks on the blockchain would be incomplete without discussing token economics. Many decentralized online social networks have native tokens, which members buy to unlock features, tip creators, or access certain services.

The token economy creates as much value for users as it does for platform owners. In some cases, especially when social networks operate as Decentralized Autonomous Organizations (DAOs), tokens give holders the power to vote on the direction of the project. This users-as-members system makes people more committed to the network and ensures its long-term survival.

Users can tokenize content and sell it to other members of the community. For example, Mirror is a Web3-native publisher that allows writers to mint their articles as non-fungible tokens (NFTs) and sell them.

Mirror users can sell articles as NFTs. Source: Medium

Influencers and content creators could further maximize earnings by creating subscription-based content. Using built-in micropayment systems like Lightning Network, content creators would be able to create steady streams of income instead of relying on platform owners for earnings.

Because blockchain projects are (mostly) open-source, users can inspect the algorithms used to control our social media feeds. No longer will Big Tech implement secret algorithms built to exploit user attention or promote divisive and harmful content.

Decentralized social networks spread the hosting of user data across multiple nodes (computers) instead of storing them on a central server. This makes it harder for anyone to aggregate and sell your data, while protecting it from hackers.

Benefits of decentralized media networks. Source: Disruptordaily.com

Challenges of Decentralized Social Networks

Decentralized social networks get a lot of hype, but they are not without downsides. As we have seen, the very features that make blockchain technology ideal can also create problems.

Censorship-resistant social applications are good until people start to spread dangerous messages. It would be difficult, if not downright impossible, to moderate such harmful content and protect users.

While decentralized social media networks promise security and failure-resistant operation, low transaction speeds may harm user experience. Imagine having to wait 10-15 minutes for your tweet to go live on the blockchain. Or waiting for 20-30 minutes for your YouTube video to upload because the network is clogged.

The immutable nature of blockchains would erase the ability to control your online activity. Today, you can delete a tweet, edit a Reddit post, or trash old Facebook pictures that may harm your reputation.

In a decentralized social media landscape, your reputation lives on the blockchain. There's no deleting tweets or archiving old LinkedIn posts that you'd rather not have a future employer see.

Every information that's put on the blockchain is permanent, always there for everyone to check.

However, the biggest problem with decentralized social media networks has to do with the technology itself. To replace centralized client-server systems, blockchain networks need to solve several design issues.

On-chain data storage is one of those problems. Blockchains were primarily developed to run applications with minimal data requirements. For example, the only information stored on the Bitcoin blockchain, or even a DeFi platform, is data related to transactions and user balances—which is negligible at best.

Social media apps require larger data storage, given the amount of data users generate. Have you wondered why your Twitter or WhatsApp seems to take up more space the more you use it? It's because you're creating more data—creating posts, uploading images, streaming videos, etc.

To truly scale and accept more users, decentralized social networks would need innovative solutions to solve blockchain data storage issues. Potential solutions include storing data off-chain on decentralized servers like Arweave, InterPlanetary File System (IPFS), and Filecoin.

Another interesting solution is using blockchains, like Deso, built specifically for social media applications. These blockchain networks typically have better on-chain storage, faster transaction speeds, and other features necessary for scaling social media applications.

Final Thoughts

Decentralized social media networks are undoubtedly one of the most exciting applications of blockchain technology yet. Blockchain-powered social applications could create a safer, private, valuable, and better experience for users and fix the broken system we have currently.

However, there's still a long way to go before a decentralized Twitter becomes widely accepted. Issues, such as poor scalability, data privacy, and on-chain storage, must be addressed fully before Web3 social media becomes a reality.

Cover Photo by Jeremy Bezanger on Unsplash

But the most enduring criticism of Bitcoin, and cryptocurrency in general, ties back to its energy consumption. Bitcoin is a transparent system, so it's easy to calculate how much power it consumes by checking the hash rate, i.e., the amount of computing power required to sustain the network.

Armed with this data, anti-Bitcoiners extrapolate the cryptocurrency's current and future energy consumption, all of them arriving at the same conclusion:

Bitcoin will destroy the Earth's climate and roll back years of gains in sustainability.

There's no doubt Bitcoin's proof-of-work consensus mechanism uses considerable energy. I explained in a recent article why the crypto industry may benefit by shifting away from proof-of-work to more efficient consensus protocols.

However, the number of high-profile stories I've seen on the topic triggered a desire to do more research. I was curious to see how many claims concerning Bitcoin's energy consumption check out.

It turns out that the issue of Bitcoin's power usage is hardly black and white. More importantly, Bitcoin critics often allow biases to influence their opinions on the matter.

This article isn't an all-out defence of Bitcoin's energy consumption. Still, I believe it is important to examine the discussion from all angles, separate myth from fact, and encourage an honest appraisal from all parties involved.

How Does Bitcoin Work?

To understand why Bitcoin uses up a ton of energy, we need to understand how the Bitcoin blockchain works and why it's useful. Those who skip this step are apt to describe Bitcoin as "dirty money" and consider miners as people who burn energy and pollute the environment to enrich their pockets.

The Bitcoin blockchain is a public record of transactions stored across a peer-to-peer network of computers. A common analogy for the Bitcoin blockchain is an accounting ledger.

The difference here is that a) thousands of computers (nodes) hold a copy of the ledger b) the ledger is append-only, so you cannot remove or alter transactions c) the majority of nodes in the network must approve a transaction before you can add it to the distributed ledger.

The cycle of a Bitcoin transaction. Source: Intellipaat.com

With our little Bitcoin 101 lesson out of the way, let's analyze how and why the Bitcoin network uses energy.

Except you live under a rock, "Bitcoin mining" is a term you're likely familiar with. Mining is the process of packaging new transactions and adding them to the blockchain.

Miners are a crucial part of the Bitcoin system, as they keep the system running. They are also responsible for securing the network by validating transactions and preventing double-spending.

By design, mining is a computing-intensive activity. Mining nodes must solve cryptographic puzzles for the right to add new transactions. Think of it as a lottery where you must "pay to play."

To increase their ability to solve these puzzles, miners invest in more powerful, energy-hungry computers. The investment makes sense, given that whoever wins the lottery gets to earn 6.25 BTC (around $250,000).

Bitcoin's energy usage, therefore, comes from the mining of new transaction blocks. Note this fact as it will come up later in this piece.

A Bitcoin mining operation in Russia. Source: Bloomberg.com

Why Does Bitcoin Mining Consume So Much Energy?

If you've come this far, then you may be asking, "why?" Why did Satoshi Nakamoto design Bitcoin to consume so much power? Was Nakamoto secretly hoping to singlehandedly trigger the climate Armageddon?

Here’s the thing: Bitcoin's computing-intensive nature is a feature, not a bug. By requiring miners to expend a valuable resource, Satoshi's PoW mechanism reduced the possibility of illicit behavior.

If a miner tried to add bad transactions to the Bitcoin blockchain, other nodes would reject it, meaning no block rewards. A dishonest miner would not only waste money spent on electricity but also lose out on those cool 6.25 BTC up for grabs.

Bitcoin is difficult, if not outrightly impossible, to hack because of its PoW structure. A would-be hacker needs to simultaneously control at least 51% of nodes, which would require a massive amount of resources.

Put simply, hacking Bitcoin is expensive—which explains why it has remained secure for years, even with no central body controlling it.

Per-hour cost of a 51% attack on popular PoW blockchains. Source: crypto51.app

A much-talked benefit of Bitcoin is its status as a "decentralized means of exchanging value." Bitcoin is decentralized because it is free from centralized control; unlike the dollar or euro, no one controls the supply of bitcoins in the economy.

This quality makes Bitcoin a hedge against inflation since no one can say, "Hey, let's produce more bitcoins." However, many fail to realize how Satoshi's genius was instrumental in turning Bitcoin into the world's first widely accepted decentralized currency.

Imagine you're Satoshi Nakamoto, and you just created the first viable, non-state currency. You need a way to introduce new units of the currency into circulation. But you also need to ensure that tiny minority doesn’t hoard the lion's share of coins.

The solution? You create a mechanism where new coins are created only after individuals expend a valuable resource (electricity). As a result, those responsible for creating these new units, i.e., miners, cannot hoard bitcoins because they need money to cover electricity bills.

You also add a feature that adjusts the difficulty of creating new currency units according to the number of miners competing for the prize. This keeps supply stable and ensures your new "Internet money" retains a finite supply, much like real money.

In a nutshell, proof-of-work is the reason Bitcoin has value. Once you understand this fact, it becomes easier to see why Bitcoin is considered "digital gold."

Gold is valuable because of the difficulty associated with producing it. Gold needs to be extracted—a resource-intensive activity—before undergoing refining and eventual conversion into gold bars.

Miners cannot control all the gold since they have to cover the costs of extraction. And the resource-intensive nature of gold mining increases scarcity and inflates gold's value.

Gold derives value from the difficulty of mining it. Source: Financial Times

As we can see, Bitcoin's PoW consensus—and its power consumption—isn't as unnecessary as critics have us believe. This point is important because debates around Bitcoin's energy consumption mostly follow the same line of argument:

Bitcoin shouldn't be allowed to use electricity because it's useless “virtual money”.

Sure, people won't come out directly to say an asset with a billion-dollar market cap is "useless," but you can notice the bias by reading between the lines. For example, here's an excerpt from an article on Bitcoin's environmental impact from The Guardian:

“Burning huge amounts of electricity isn’t incidental to bitcoin: instead, it’s embedded into the innermost core of the currency, as the operation known as “mining”. In simplified terms, bitcoin mining is a competition to waste the most electricity possible by doing pointless arithmetic quintillions of times a second.”

Our friendly author here is obviously parroting the same "Bitcoin is useless, so let's stop mining" line. Such people have never taken the time to understand how the Bitcoin protocol works and why proof-of-work is an integral part of the system.

Common Misconceptions About Bitcoin's Energy Consumption

The Bitcoin community has gotten used to seeing common misconceptions about the crypto asset pushed by media pundits. However, some of these misconceptions—especially those related to Bitcoin's energy use—are baffling since some quick research would reveal the truth.

Let's look at some popular claims about Bitcoin and see if they hold up under rigorous examination:

Myth 1: Bitcoin's Energy Usage Rises With Transactions

Critics caution against the mass adoption of Bitcoin, saying that a rise in Bitcoin transactions would adversely affect the environment. The thinking is that energy consumption is tied to the validation of transactions on the Bitcoin blockchain.

If only people would take Bitcoin 101 before writing misleading articles!

Validating Bitcoin transactions is a simple task your cheap home PC can perform. Mining, which involves bundling transactions and broadcasting them on the blockchain, is what increases Bitcoin's energy requirements.

So, no, Bitcoin's energy usage won't skyrocket if it becomes a widely accepted currency in the future. Even if that were the case, the growth of Layer 2 solutions like Lightning Network capable of bundling thousands of transactions into one would solve the problem.

Myth 2: Bitcoin Will Remain Inefficient Forever

Environmental do-gooders like to rail against Bitcoin because they believe the cryptocurrency will continue to burn energy forever. Their reasoning is based on questionable research, including a debunked study that claimed Bitcoin would cause the Earth's temperature to "rise by two degrees Celsius."

A closer look reveals a glaring flaw in this argument: these claims extrapolate Bitcoin's future energy usage from current consumption figures. Which is just poor reasoning if you asked me.

We've already established that mining accounts for most Bitcoin's energy usage. However, mining won't continue to consume copious amounts of energy forever.

Mining is lucrative currently because of the associated block rewards (6.25 BTC or $268,000 at the time of writing). Thus, miners are incentivized to buy powerful Graphical Processing Units (GPUs) and Application-Specific Information Computers (ASICs) to increase their chances of mining new blocks.

Bitcoin's proof-of-work mechanism is designed to reduce the block reward every 210,000 blocks (roughly four years). Known as "the Halving", this process explains why block rewards have dropped from 50 BTC to the current 6.25 BTC.

Historical halvings of Bitcoin’s block reward. Source: @ChartsBTC

Per calculations, the next halving will occur in 2024, reducing block rewards to 3.125 BTC. Although it's hard to know the precise time, we can expect the block reward to eventually drop to 0.

Miners will continue to mine transaction blocks, but their earnings will come from transaction fees, not block rewards. The lucrativeness of Bitcoin mining will drop, meaning no one would bother investing in high-grade computing power for mining.

If miners reduce their power use in the future, then it follows that Bitcoin will become efficient. Anyone saying Bitcoin will become the sole trigger of the climate change crisis clearly doesn't have the facts right.

Myth 3: Bitcoin Mining Causes Environmental Pollution

Several statistics concerning Bitcoin's perceived pollution base their calculations on the energy consumption of Bitcoin miners. Bitcoin uses so much energy, so it must be polluting the environment—right?

In reality, things aren't as straightforward.

For starters, high energy consumption doesn’t equal high pollution. You cannot simply estimate pollution figures without knowing the precise mix of energy sources used.

Here's an illustration:

Two companies, XAZ Corp. and XYZ Inc. use 15 terawatts and 10 terawatts of energy annually. While XAZ Corp. uses solar energy, XYZ Inc. uses fossil fuels (crude oil).

To the average individual, XYZ Inc. is more "energy-efficient" since it burns less energy. But the truth is XAZ Corp. has a lower carbon footprint since it uses a renewable and cleaner source of energy.

The same concept applies to Bitcoin mining. Until anyone can reliably confirm what kind of energy miners prefer, calling Bitcoin "dirty money" is a logical overreach.

Perhaps it's important to note that miners have historically favored regions with large supplies of renewable power.

China became the world's mining capital because several inland regions there had excess amounts of hydrothermal energy. Other mining hotspots, including Iceland and Texas are popular among miners because they also offer access to cheap, eco-friendly power.

Because electricity accounts for 60-70% of mining costs, miners have to look for the cheapest sources of power. As such, it's safe to believe Bitcoin mining could single-handedly drive the renewable power industry.

Not so dirty now, is it?

Bitcoin miners prefer cheap sources of energy, like wind power. Photo by American Public Power Association on Unsplash

Myth 4: Bitcoin Mining Is Useless and Wasteful

There’s something we need to understand about the Bitcoin energy debate. Most arguments are less about Bitcoin's power use and more about whether using so much energy is justified.

After all, the fiat banking system consumes similar amounts of power—think of the energy used by ATMs, bank buildings, and other key players. Still, you don't see anyone calling the dollar "dirty money."

The first section of this article has explained how mining helps Bitcoin achieve the decentralization, security, and scarcity needed for a store of value. However, there are even more reasons why Bitcoin's resource intensiveness is an acceptable tradeoff.

Bitcoin miners are maintaining and securing a payments system processing billions of dollars annually—without any pulling strings in the background. Moreover, the Bitcoin blockchain is a final settlement layer, meaning transactions are fast, irreversible, and secure.

With Bitcoin, anyone can send and receive money from anywhere in the world, as long as they have an Internet connection. For the millions of unbanked individuals, Bitcoin is their only chance at sidestepping cumbersome regulations and participating in the global monetary system.

Bitcoin is revolutionary, and mining is a critical part of its infrastructure.

Some may point to more efficient consensus algorithms like proof-of-stake or proof-of-authority. However, these consensus mechanisms often trade-off decentralization and security for faster transactions.

No matter how you slice and dice it, Bitcoin's energy intensiveness is a necessary evil if we hope to create a secure, inclusive, and independent monetary system.

Final Words

As we have seen, Bitcoin’s energy use has been exaggerated and inaccurately framed by individuals bent on discrediting its value. If the mainstream media’s anti-crypto propaganda machine continues to run, then you can expect more articles painting Bitcoin as the biggest threat to the Earth’s survival.

Bitcoin believers know that arguing about the cryptocurrency's energy use is missing the forest for the trees. Yes, Bitcoin may be resource-intensive—but the value it provides is more than enough justification for its energy consumption.

Using Twitter and Apple as examples, Andreesen argued that software providers would displace legacy institutions and create new business models. Of course, he was right.

Today, blockchain is eating the world.

Across multiple industries, blockchain technology is disrupting age-long corporate structures and creating business models that are decentralized, secure, and efficient. Already, the number of enterprises expected to adopt blockchain technology is growing everyday.

Even with these facts, many outsiders still doubt the blockchain's transformational value.

That’s why I've decided to start a monthly roundup of the best blockchain-based projects. Perhaps by seeing the various applications of blockchain technology, we can start taking this industry seriously.

The series will highlight various real-world solutions using blockchain technology. As much as possible, these roundups will cover novel use-cases beyond the usual (NFTs, DeFi, cryptocurrencies, etc.).

Also, I plan to highlight products with utility (read: sensible products), so you probably won’t see a “blockchain meets OnlyFans” app on the list.

Let's go!

Status

Source: Status.im

Today’s social network users have to face centralization, censorship, loss of privacy, lax security, and many more ills. Many have since launched several blockchain-based social platforms to correct these problems and provide users with a better experience.

Social networks running on the blockchain promise greater decentralization, security, privacy, and censorship resistance. And that’s what makes Status truly unique.

Status is an all-in-one solution comprising a secure messaging app, cryptocurrency wallet, and Web3 browser.

Messages sent on Status’ private messenger use end-to-end encryption, meaning nobody can snoop on messages. The app’s peer-to-peer infrastructure further prevents centralization and protects users from censorship.

Anyone can join Status without giving up confidential information, like email addresses, phone numbers, or bank accounts. Users can also send money in chats via the integrated wallet, making payments faster and cheaper.

Status Wallet is a non-custodial option for safeguarding ERC-20 and ERC-721 tokens. Meanwhile, the native browser serves as a gateway to the decentralized Internet, allowing users to access decentralized applications (dApps), exchanges, games, and more.

Source: Status.im

Status is free and open-source, although users must purchase the Status Network Token ($SNT) to run certain applications. SNT tokens incentivizes users to sustain the network and gives holders voting power on major network proposals.

Pledgecamp

Source: Pledgecamp.com

Crowdfunding has been the rage ever since Kickstarter and Indiegogo launched, growing to a billion-dollar industry in recent years. Although crowdfunding has provided a way for people to back their favorite projects, there are problems with current crowdfunding models.

Perhaps the biggest of these problems is accountability. Crowdfunding platforms have little mechanisms for enforcing accountability, leaving project founders to act as they please. Often, there’s nothing backers can do if projects are delayed or fail to ship products as promised.

Pledgecamp solves this problem by applying blockchain technology to the crowdfunding process. The platform uses smart contracts to control the allocation of funds to project creators. Instead of getting paid in full upfront, creators must satisfy project milestones before having more money released to them.

Pledgecamp allows project backers to track funds and monitor progress of their favorite projects. And if the project team fails to deliver? Funds locked in escrow are reallocated to donors, while the errant creators suffer sanctions.

Source: Pledgecamp.com

Pledgecamp is a self-sustaining dApp ecosystem running on Ethereum, with its native token (Pledge Coin). Users support projects by buying Pledge Coin, but they can also earn PLG by offering services, like marketing, to project creators, or sharing valuable information via the Knowledge Center.

Beyond the security and transparency it offers, Pledgecamp makes crowdfunding more inclusive. Kickstarter is only available to project creators in just 25 countries and users must have a bank account. This cuts off many people from crowdfunding campaigns—namely, users living in unsupported countries and unbanked individuals.

Blockchain technology allows people to transact seamlessly and securely across borders. As a result, anyone can launch or fund a project from any corner of the world with Pledgecamp.

Source: Pledgecamp.com

Numbers

Source: Numbersprotocol.io

A budding photographer takes a great picture and uploads it to Instagram. Within minutes, that image is floating around the Internet without anyone crediting them for their work.

Copyright infringement and piracy is a big concern for photographers, with statistics claiming up to 2.5 billion unlicensed images are stolen daily. While stock photography (Shutterstock, iStockPhoto) has reduced unlawful use of images, problems still persist.

Numbers is a decentralized photo network seeking to give creators more control over their work, while restoring faith in digital media. It has been featured on TechCrunch and counts Binance and Protocol Labs as investors.

Numbers prevents image theft by securing images with blockchain technology. Details such as who owns the image and when and where it was taken are encoded into the certification seal and stored on the blockchain.

Source: Numbersprotocol.io

The Numbers product ecosystem also includes the Capture app, a “blockchain camera” that automatically generates on-chain metadata for images. Users can turn these great photos into non-fungible tokens (NFTs) and sell them on Capture Club, a marketplace for photo NFTs.

For creators, Numbers is the perfect solution for securing ownership of images and protecting intellectual property (IP) rights. Users also benefit since they can verify the history and authenticity of images, potentially reducing image fakery and photo manipulation.

Numbers has a native ERC-20 token ($NUM) which users buy to use the various services. For example, users can register copyrights as well as buy, gift, and sell NFTs using their $NUM tokens.

Blockcerts

Source: Blockcerts.org

Blockcerts is an open standard for creating, issuing, and verifying digital certificates on the blockchain. Blockcerts ("blockchain certificates) can be used to issue academic degrees, certificates, recognition of accomplishments, and many more.

If you applied for a job today and submitted your certificate, employers would need to check its veracity by contacting the school. And that itself is a long, problematic process.

With Blockcerts, users truly own their records and can share them with anyone, including potential employers. Employers can verify the validity of Blockcerts for free using the Universal Verifier.

Blockcerts is simple to use. To illustrate, let's imagine a university (Hogwarts) needs issue a Blockcert to Bob:

Hogwarts University invites Bob to receive a blockchain credential. Bob sends his blockchain address. Then Hogwarts University hashes the credential on the blockchain.

Bob gets a blockchain credential from Hogwarts University, which he shares with a prospective employer. The employer enters Bob's certificate URL into the Universal Verifier and gets confirmation of the credential's authenticity similar to the image below:

Source: Hylandcredentials.com

Thanks to the blockchain's immutability, Blockcerts cannot be altered—lest they become invalid. Plus, the Universal Verifier can show important details about the credential such as:

• The date of issuance (transaction date)
• The issuing institution
• The issuer's public key
• The transaction ID
• Certificate validity

Blockcerts also offers users a wallet to store and share their credentials. Blockcerts are verifiable for a lifetime, so users can still own records even if the institution isn't around anymore.

Here is a list of demo Blockcerts credentials you can verify to see how it works.

Lightning Pizza

Source: LN.Pizza

On May 22 2010, Laszlo Hanyecz bought two Papa John’s pizzas for 10,000 BTC in what is considered the first real-world transaction involving Bitcoin. With Bitcoin trading over $39,000 now, Laszlo’s stash (worth $41 at the time) would sell for $390 million now.

The event is entrenched in cryptocurrency lore, inspiring Bitcoin Pizza Day, and an app for ordering pizza using—yes, you guessed it—Bitcoin. The Lightning Pizza app allows U.S. residents order Domino’s pizza from any location and pay with BTC.

You’re probably asking, “what is world-changing about a pizza delivery app?” While Lightning Pizza may seem trivial, the Lightning Network on which it operates is anything but.

Source: Coinscreed.com

Lightning Network is a Layer 2 scaling solution built on top of the Bitcoin Network. Lightning allows users to conduct transactions off the main Bitcoin blockchain, making cryptocurrency payments faster and cheaper.

Say you need to buy coffee at Joe’s shop downtown with Bitcoin. Some would describe Bitcoin payments as impractical, given the high transaction costs and long confirmation times.

However, Lightning ensures your payment to Joe doesn’t go through the main Bitcoin blockchain. Instead, the money moves through a peer-to-peer, off-chain channel which you create at the start of the transaction.

Here's an illustration of a Lightning payments channel works:

At the start of the transaction with Joe, you create a two-way payment channel and deposit some bitcoins. This channel uses multisignature technology, meaning funds deposited cannot be moved without two keys signing the transaction.

Think of the channel as a smart contract since it prevents one party from unilaterally moving funds. Every time you buy coffee from Joe’s Shop, both of you sign off on a transaction paying the business.

Once the initial deposit is exhausted, both parties can close the channel and have the final transaction recorded on the Bitcoin blockchain. Only the last transaction is recorded, meaning you can conduct multiple Bitcoin transactions without heavy transaction fees.

Source: Dignited.com

Lightning Network channels can process millions of micropayments per second and may revolutionize online payments. Here’s a chart comparing the Lightning Network to other payment solutions:

Micropayments have many uses, especially for small businesses, as Lightning Pizza shows. But we can also apply the technology to online businesses.

Specifically, digital content creators can use micropayment channels to accept small payments (tips, subscription fees) from fans. A good example is Tipping.me, a Lightning-based browser extension which anyone can use to tip their favorite content creators on Twitter.

Source: Bitcoin Magazine

Final Thoughts

Blockchain technology continues to evolve, with more use-cases appearing. These new solutions promise many benefits—for businesses and consumers—and show that blockchain technology is beyond cryptocurrencies and NFTs.

Got any blockchain project(s) you want to see reviewed? Drop your thoughts in the comment section or reach out to me with your suggestions!

Cover image courtesy of Venafi.com

Except for crypto-punks, computer geeks, and random Joes, not many people give this new magic Internet money any attention. That is, until the value of Bitcoin skyrockets, so much that random Joes become millionaires overnight.

Now, it's 2022. Everyone is getting on the crypto bandwagon, and you don't want to miss out. Yes, you missed crypto's initial bull runs—but don't the Chinese say the best time to plant a tree was 20 years ago, and the second best time is now?

However, Bitcoin’s classification is unclear, so you’re unsure if investing in Bitcoin is legal or not.

Are Bitcoin investments legal? What are the legal risks of investing in Bitcoin? What is the current regulatory framework around cryptocurrencies, including Bitcoin?

This article answers these questions and details what you should know before putting your cash in Bitcoin investments.

Analysis of Bitcoin Investment Regulations Around The World

Given its nature as a decentralized digital asset, Bitcoin's legal status was always going to cause major debate. Thirteen years after Bitcoin's arrival, governments and regulators haven't reached a consensus on its classification.

However, as more people continue to buy Bitcoin, governments worldwide are starting to take notice, leading to increased regulation. This next section covers the legal status of Bitcoin in several countries:

USA

Ownership of cryptocurrencies like Bitcoin in the US is growing, with statistics putting American crypto users at 27 million—one of the highest in the world. According to a recent study from Pew Research Center, 16% of Americans say they have invested, traded or used crypto is 16%, up from 1% as found in a 2015 study.

Bitcoin investments are not illegal in the USA, although the regulatory framework is hardly streamlined. Legalese on Bitcoin's status varies among financial regulators in the US, so let's look at some of them.

In 2014, the Internal Revenue Service (IRS) released a notice announcing the classification of Bitcoin as a property. As a result, investors must pay capital gains tax on profits realized from transactions involving Bitcoin. The upside here is that your tax bill will reduce if you sold Bitcoin at a loss.

The IRS has increased regulatory oversight over Bitcoin investments in recent years. For example, it announced in 2020 that individuals would need to disclose Bitcoin-related transactions on Form 1040.

You won't have to pay taxes if you simply buy Bitcoin with fiat and hold it in your wallet. This is known as HODLing in crypto-speak and means leaving your coins to rise in value.

The IRS is only interested in transactions involving your Bitcoin. So if you exchanged crypto for dollars, traded it on an exchange, or paid for goods with Bitcoin, then you need to disclose such activity on your tax form.

The Commodities and Futures Trading Commission (CFTC) classifies Bitcoin as a "commodity," just like gold or crude oil. The CFTC's position on Bitcoin is contained in a 2017 report, where the Commission limits its oversight activities to futures, options, and derivatives involving Bitcoin.

Although CFTC has warned against the risks of investing in cryptocurrencies, it is open to supporting innovation in the sector. The Commission has since said it would promote "responsible innovation in digital assets," while cracking down on "those who break the rules."

True to its word, the CFTC went after BitMex exchange for failing to register its cryptocurrency derivatives trading platform. The result was a court order asking BitMex to pay $100 million in fines.

The BitMex saga is a lesson for any would-be Bitcoin investors in the US. Before you start trading Bitcoin options, futures, and derivatives has CFTC approval to avoid legal exposure.

The Securities and Exchange Commission (SEC) shares the same sentiments with the IRS about Bitcoin, classifying the digital asset as a property. Former SEC Chair Jay Clayton went on record in 2018, saying "Bitcoin is not a security and should not be taxed as such."

However, it is important to note that the SEC considers other cryptocurrencies distributed through an Initial Coin Offering (ICO) as securities. This means you'll have to pay security tax on Ethereum, Ripple, Stellar, Cardano, Polkadot, and other altcoins.

The Financial Industry Regulatory Authority (FINRA) doesn't regulate the investment of Bitcoin and other investments. However, it regulates the activities of brokers handling Bitcoin investments on behalf of investors.

Understanding FINRA's role in Bitcoin investments is crucial for potential investors, especially those who wish to invest using sophisticated financial instruments. Because the agency supervises cryptocurrency brokers, you can file a complaint if you lose money due to your broker's actions or inactions.

FINRA cannot help if your crypto broker isn't adequately registered. It is up to you to confirm if the broker or brokerage firm handling your Bitcoin investments has a FINRA licence.

United Kingdom

As with the United States, the United Kingdom has never said buying Bitcoin is illegal. However, UK citizens are liable to pay tax on Bitcoin holdings—this may be income tax or capital gains tax.

The tax you pay depends on what transactions you make with cryptocurrencies. Those considered to be making an income are subject to income tax laws, while anyone making capital gains pay capital gains tax.

For example, you must pay tax when you 'dispose' of Bitcoin, like you would do for any capital asset. This means you are liable to pay capital gains tax when you sell, trade, spend, or gift Bitcoin.

Her Majesty's Revenue and Customs (HMRC) will charge an income tax if you're getting returns from your Bitcoin investment. So, if you're earning dividends from staking, lending, or yield farming, an income tax payment is in order.

UK investors who wish to invest in Bitcoin trading derivatives like their US counterparts are, unfortunately, out of luck. This is because of a Financial Conduct Authority (FCA) ban on the sale of cryptocurrency derivatives to retail investors issued last year.

Citing the complex nature of cryptocurrency derivatives as reason for the ban, the FCA said it was "protecting investors" with the law. However, commentators are concerned the ban will push investors to consider riskier, unregulated alternatives.

Another note for UK Bitcoin investors: check if an exchange has FCA approval before trading on it. The agency has a list of unregistered exchanges and placed restrictions on Binance last year for failing to register properly.

The FCA has said in the past that cryptocurrency investors are unlikely to have access to redress mechanisms if anything happens with their investment. Consider this carefully before you "buy the dip" and load up on Bitcoin.

India

India has been in a dance of sorts with Bitcoin for a long time. The Reserve Bank of India (RBI) banned the sale, investment, and trading of Bitcoin and other cryptocurrencies in 2018. In a widely circulated announcement, the country's apex banker warned financial institutions against facilitating crypto-related transactions.

Things took a new turn after the Supreme Court of India overturned the ban in 2020, allowing Indians to buy, sell, and hold Bitcoin. However, the RBI hasn't stopped its drive to regulate Bitcoin investments and has drafted a new set of rules to guide the sector.

For instance, it recently announced a 30% income tax on all crypto holdings. Interestingly, the apex bank said the tax doesn’t mean Bitcoin trading is legal in India.

Key people in the RBI have shown marked opposition to Bitcoin and other cryptoassets. This includes the RBI Deputy Director, T. Rabi Sankar, who called cryptocurrencies "a Ponzi scheme" earlier this year and called for a total ban.

As of now, there's no law saying Bitcoin investments are illegal in India. Still, it's better to exercise caution when investing—especially if the RBI continues its dogged opposition to cryptocurrencies. While another outright ban is unlikely, consider withdrawing your money if signs point to another asset freezing attempt.

Europe

Much like other regions, the European Union has found it difficult to reach consensus on the nature of Bitcoin investments. The most notable EU legislation on Bitcoin is a 2015 ruling from the European Court of Justice (ECJ) exempting the purchase of cryptocurrencies from Value Added Tax (VAT).

Beyond the ECJ ruling, countries in the EU have different laws regulating investments in Bitcoin and cryptoassets.

In France, cryptocurrency gains are taxed only when converted to fiat money, i.e., "cashing out". This means you don't have to pay taxes on gains from trading Bitcoin for other cryptocurrencies.

In Austria, anyone holding Bitcoin as a non-business asset is required to pay gains tax on profits realized during the one-year "speculative period." Bitcoin investors can avoid paying taxes if they hold their assets for more than a year.

The same law applies in Germany, where capital gains on cryptocurrency are tax-free after a holding period of at least one year.

Things are a bit different in Malta. Here, the government recognizes Bitcoin as "a unit of account, medium of exchange, or a store of value" and exempts long-term holders from capital gains tax or VAT.

Maltese residents must pay taxes on day-to-day cryptocurrency trading, though. Regulators consider crypto trades similar to day trading in stocks, which makes such transactions taxable as business income.

Africa

Africa has one of the highest rates of cryptocurrency users in the world, with countries like Nigeria boasting some of the fastest-growing cryptocurrency trading communities in the world. Despite this, regulation has been unclear in many areas.

South Africa is one of the few African countries with clear policy on cryptocurrency-related investments. While Bitcoin isn't considered legal tender in the country, the South African Revenue Service (SARS) treats Bitcoin as an intangible asset and taxes profits realized on acquiring or selling units of Bitcoin.

Nigeria, Africa's most populous country and the world's largest Bitcoin market after the US, restricted banks from processing crypto-related transactions and warned against dealing with financial institutions involved in cryptocurrencies.

However, the move has done little to stop citizens, many of whom have turned to peer-to-peer exchanges to buy, sell, and trade Bitcoins and other altcoins.

Asia

Like India, many of Asia's biggest nations have taken a tough stance on cryptocurrencies, including Bitcoin.

China cracked down on crypto last year, banning Bitcoin mining and the trading of digital assets in all its regions. Russia has since copied China's example, proposing to ban cryptocurrency mining and trading in the country.

Ironically, both China and Russia are among countries working on Central Bank Digital Currencies (CBDCs). CBDCs are government-issued cryptocurrencies, backed by a central bank.

Final Thoughts

As we have seen, investing in Bitcoin is not illegal in most countries. However, investors must understand current regulations to avoid breaking the law, especially concerning paying taxes.

It goes without saying, but don't invest in Bitcoin money you cannot afford to lose. Bitcoin is a volatile asset that rarely promises consistent returns, so be careful to research well before investing.

There's even a movement dedicated to curating the hardest-hitting criticisms of Web3 on the Internet.

With all the flak Web3 gets online and offline, you have to wonder:

Why does everyone hate Web3?

Understanding Web3 Criticism

Web3 is the vision of a decentralized Internet, where control users—not Silicon Valley behemoths—control their data. The concept originated in a 2014 paper by Ethereum co-founder, Gavin Woods, and has come to signify a user-owned Internet that allows everyone to communicate and exchange value without relying on trusted intermediaries.

The Web3 technology stack includes decentralized applications (dApps), blockchains, cryptocurrencies, and smart contracts.

If Web3 is so revolutionary, why does it trigger vitriolic criticism from some of the biggest names in technology?

The simple truth is Web3 is the kind of lightning-rod topic that's bound to draw reactions—whether from bullish supporters and fiery critics. As a result, everyone is trying to ride the coattails of Web3 criticism to Internet superstardom.

"Everyone" here includes The New York Times, Signal co-founder Moxie Marlinspike, socialist publication Jacobin Magazine, and leading tech publications like TechCrunch and Vox.

Of course, there's more here, here, here, and here.

Critics not only target Web3, but also attack the building blocks of the technology. Which means you'll find the Financial Times calling crypto a Ponzi scam, CNET saying NFTs don't make sense, or The Verge describing blockchains as "meaningless".

I could dig for more links, but you get the idea—Web3 is gaining steam, and many people don't like it.

Now, some of these people have good reasons for criticizing Web3. The technology is relatively new, with many kinks to work out, yet evangelists describe it as the greatest technological revolution since the arrival of the Internet.

I'd be mad, too. In fact, I recently criticized smart contracts in a recent article, highlighting their design flaws and limited real-world applications.

But here's the thing:

Technology always evolves, so I expect the introduction of smarter smart contracts, scalable blockchains, and environmentally sustainable cryptocurrencies. That's why I remain bullish on Web3 and its ability to remake the Internet into a better place for all.

However, some people are dead-set against the technology and believe it offers no solutions or creates new problems. These people are the focus of the article.

After going through a long list of anti-Web3 material online, I have a good idea of the various profiles of Web3 haters. This next section discusses the different types of people who hate Web3 and their reasons for criticizing the technology.

Let's dig in, shall we?

The Hard-Nosed Journalist

I'll start with our good friend here—the hard-nosed journalist. Trained to be straight as a ruler and report news without fear or favor, the hard-nosed journalist takes no prisoners on the job.

You can expect the hard-nosed journalist to ask the tough questions, criticize anything and everything, and provide independent, against-the-grain commentary on societal issues.

All of that is good. In fact, I wager the world would be worse off without journalists. We'd probably never know about Watergate, Guantanamo Bay, the CIA’s involvement in the drug trade, or Big Tech's desire to monopolize the Internet if journalists hadn’t risked their lives to find out the truth.

However, it's become the unspoken rule in journalism that bad news gets more coverage than good news. Good news may inspire people, but it's the bad news that drives clicks and keeps the lights on.

People love bad news, and the media ruthlessly exploits this negativity bias to attract more eyeballs. That explains why so many stories and op-eds in mainstream media concerning Web3-related concepts like cryptocurrency and blockchain technology are intensely negative.

It makes economic sense to give readers negative news about a sector if that's what they want.

Take for example this story from The Guardian about right-wing extremists raising funds with crypto. Or this one from Wired about Russian hackers using Bitcoin to fund operations.

There's nothing wrong about journalists seeking to highlight the dark side of Web3. Given the rate of criminal activity—ICO fraud, hacks, exit scams, Ponzi schemes, money laundering, et al—that happens in the industry, we need people to call out bad actors.

But when an entire industry consistently gets negative coverage, we need to question the fairness and balance of journalists.

It gets worse when journalists try to undermine the entire Web3 industry on the basis of some malicious actors. They literally act like criminals aren't early adopters of new technology. Whether it's cars, pagers, or cell phones, criminals are always one of the first groups to recognize the potential of new innovations.

I suspect journalists know the danger of biased reporting, but the need to attract readers overrules the desire to comply with journalist ethics.

So, next time you see an anti-Web3 article from one of 'em hard-nosed journalists, my advice is to take it with a pinch of salt (I prefer ice-cream). Do not listen to the media on blockchain or Bitcoin or anything remotely related to Web3.

The Contrarian

The Cambridge Dictionary defines a contrarian as "someone such as a writer or politician who likes to disagree with other people and express opinions that are unpopular."

Put simply, a contrarian is someone who likes going against prevalent thinking. This doesn't mean the contrarian's take on issues is particularly correct. If anything, public rejection of the contrarian's ideas is proof that those ideas lack merit.

But contrarians don't need to be correct about anything. So long as they can produce unpopular opinions, their share of public attention is guaranteed. Again, people love the negative stuff—and contrarians give them loads of it.

Contrarians are always against popular things or ideas. The contrarian is the type of person who said the Internet was overhyped in 2000, predicted the death of hybrid cars, and dismissed the idea of exploring Mars.

Web3 has been riding the hype curve since last year, so I can understand the intense reactions the topic triggers in contrarians.

There's no shortage of contrarians trying to break the Internet by criticizing Web3 in articles and blog posts. Some of it, like this one from Moxie Marlinspike, try to address real issues in Web3 constructively.

The rest are simply ego-boosting, click-baity articles poorly disguised as informed commentary. Once an article starts with something like "Web3 Is Bullshit" or "Nobody Cares About Decentralization," you can bet the author is desperately trying to be contrarian.

I have no problems with contrarians. After all, our capitalist thrives because people can contribute to a diverse marketplace of ideas.

That doesn't mean I regard them highly, either.

People seem to forget how easy it is to criticize. As Dale Carnegie said: "Any fool can criticize, complain, and condemn—and most fools do." It's much harder to fix things and build products that offer consumers a better experience, something many in Web3 are trying to do.

No one would care about Web3 if the current Internet was oh-so-good. Are there problems with Web3? Yes. But there are people—smart people, I must add—working to solve these problems.

Contrarians offer no value beyond showing us what the problems are. It’s an intellectually lazy act that’s no different from idealistic teenagers scrawling “Society is fucked” on crappy t-shirts.

The Doomsday Prophet

Merriam-Webster defines doomsday prophets as "people who predict that bad things will happen." What it fails to add is that some doomsday prophets are people paid to predict bad things will happen.

Doomsday prophets, or pessimists, have always exploited negativity bias to their advantage. People like Nobel Laureate Paul Krugman built an entire career on issuing alarming predictions that never materialized.

Now, the same doomsday prophets have turned their attention to cryptocurrencies, blockchains, and everything related to Web3.

Guess who's leading the pack? Paul Krugman. The same man who said "the Internet would fizzle out" in 2005, and predicted that "the Internet's effect on the economy would be no greater than fax machines."

The doomsday prophet is the kind of person who says Bitcoin will cause the Earth's temperature to rise by two degrees celsius based on calculations done with questionable data. Thankfully, we still have rational people who can debunk these wild theories and show that, yes, things are not all doom-and-gloom.

Doomsday prophets predicted "the fall of Bitcoin'' in 2011 and declared Bitcoin ''a bubble ready to pop'' in 2013. In 2022, yet another prophet of doom says Web3 will fail because "you can't solve politics with technology."

You'd think doomsday prophets would have learned a thing or two about predictions, but what do you know?

As the popularity of Web3 increases, you can expect more, more, more, and more doomsday predictions about crypto, blockchains, NFTs, and Web3 to circulate online. But no one is fooled about the motive behind these predictions: to gain attention and drive buzz.

The Luddite

According to the Oxford Dictionary, a Luddite is "someone who dislikes new technology." The Luddite is a different flavor of Web3 critic, one who hates the tech because he is a) resistant to new technology b) unwilling to learn anything.

Compared to their 19th century counterparts, modern-day Luddites are found in the highest echelons of society. A person could be the CEO of a hedge fund and be a Luddite without anyone knowing.

However, you can smell a Luddite by their marked criticism of new technology. These are the people who ask generic questions like, "What problems does this technology solve?" even if the topic has been discussed repeatedly.

Of course, a week or two of research should solve this problem. But, alas, the Luddite's hatred of new technology is too deeply ingrained for him to consider the possibility that this technology might have some benefits.

Luddites are resistant to technology for many reasons. But the most enduring is the threat new technology poses to their jobs, and by extension, their lives.

The original Luddites destroyed machinery during the Industrial Revolution to protect their manual jobs. Modern-day Luddites want to destroy Web3 because it threatens to overturn the broken economic structure that enriches them.

You can see it in the way legacy institutions routinely describe cryptocurrencies as Ponzi schemes, dismiss decentralized finance (DeFi), or deride blockchain technology.

I totally get it. If something like AI writing software threatened my job, downplaying its importance would be my Life Mission.

However, acting this way is rarely ideal. A better strategy would be to look into strategies for adapting to new technological trends and positioning for future survival.

In a capitalist society, change is inevitable; new ideas always replace old ideas. Television killed cinemas, news websites killed newspapers, and iPods killed mp3 players. On and on it goes.

This process of "creative destruction" is what fuels innovation in the 21st century and moves society forward. Legacy institutions trying to protect their businesses by spreading FUD (Fear, Uncertainty, and Doubt) concerning Web3 is like trying to stop a moving train instead of getting on it.

Some blue-chip companies like JP Morgan have made a U-turn on blockchain technology, crypto, and the wider Web3 revolution. Still, you can expect more Wall Street types to resist Web3 and throw everything they have at it.

The catch? Web3 isn't going anywhere soon. And like those Luddites of yore, modern-day Luddites will have no choice to adapt or lose out.

The Soapbox Speaker

Throughout the 19th and 20th centuries, public speakers would stand on soapboxes (discarded crates) at street corners and attempt to garner support for a specific cause. Some of history's greatest thought leaders and revolutionaries got their start in soapboxing.

Soapboxing has carried over into the 21st century, but the mechanics have changed. For example, Donald Trump proved the power of rallying supporters around particular issues by riding the waves of American anti-immigrant phobia and white nationalism to the White House.

From failing politicians to environmental do-gooders, there's no shortage of people using Web3 as leverage to garner supporters.

Politicians like Elizabeth Warren would have you believe that cryptos are threatening the financial system and should be regulated to death. A simple history lesson, however, shows crypto was designed to solve our broken financial system and ensure things like the 2008 financial crisis never happen again.

In similar fashion, so-called environmental activists score relevancy points by painting blockchains and cryptocurrencies as the world's no. 1 environmental problem. That's when you see articles like this saying Bitcoin mining will destroy the Earth and accelerate the climate change apocalypse.

Perhaps some due diligence will show Bitcoin miners have resorted to using renewable sources of energy, like wind farms and hydroelectric plants. Moreover, are we going to pretend like the banking system doesn't consume similar amounts of energy?

I suspect our friendly soapboxers here know the truth, but then that's not enough to gain new supporters. They must show relevancy, and Web3 is the newest bull to sacrifice for the goal.

The Final Word

I don't doubt that Web3 has many problems. But the constant barrage of extreme criticisms I see on the Internet everyday are baffling and show the human tendency to resist innovation for often selfish reasons.

Perhaps in the future, people will learn not to fear what they don't understand. For now, you can expect people to keep hating on Web3 and reaping the rewards.

Not that it should bother true believers in Web3 technology. I mean, there's a long list of people who predicted that the Internet would never take off.

It takes years, decades even, for people to see the potential in technology. Some are lucky to discover it early, while others fail to see until it's here.

Will Web3 fail or succeed? Only time will tell.

In the meantime, you can wait for the next anti-Web3 article and laugh at those desperately trying to stop a change whose time has come.

WAGMI.

However, research reveals an ugly fact about Satoshi Nakamoto's consensus protocol:

Proof-of-Work cannot work any longer—at least if we want to cryptocurrencies to become widely accepted.

In light of the problems with Proof-of-Work, a new consensus algorithm called Proof-of-Stake has become the popular choice for newer blockchains. Proof-of-Stake blockchains promise faster transactions, higher scalability, a lower carbon footprint, among other benefits.

This article attempts to make sense of the Proof-of-Stake vs Proof-of-Work debate and why it matters. We'll consider the potential benefits of a PoS blockchains and risks associated with this novel consensus mechanism.

The Problem With Proof-of-Work

Last month, the US Congress held its first hearing on the topic of regulating cryptocurrencies. The question before the House Committee on Energy and Commerce was simple: How do we make cryptocurrency environmentally sustainable?

It is no longer news that the electricity consumption of cryptocurrency is comparable to many countries. If anything, high energy usage and its attendant environmental impact is the major complaint levelled against cryptocurrencies like Bitcoin and Ethereum.

The blockchain technology powering Bitcoin, Ethereum, and dozens of altcoins relies on a Proof-of-Work consensus mechanism to secure the system and prevent malicious actions, such as double-spending of funds.

Proof-of-Work (PoW) is the original solution developed by Bitcoin's original founder, Satoshi Nakamoto, to confirm the validity of transactions in the absence of a trusted intermediary.

An explanation of the PoW mechanism would fit into an entire article, so we'd stick to the basics here.

PoW consensus systems require network participants to solve complex cryptographic equations before validating new blocks and adding them to the blockchain. Also called mining, this activity demands enormous computing power from miners.

Because the network rewards whoever solves the problem first, miners can invest in higher computing power to increase their chances of getting mining rewards. Unsurprisingly, this leads to greater energy consumption, which is why criticism of cryptocurrency's energy usage is rife.

What is Proof-of-Stake?

Proof-of-Stake (PoS) is an alternative consensus mechanism that fixes many issues with the PoW system. Created in 2012 by Sunny King and Scott Nadal, the developers behind Peercoin, Proof-of-Work is used by blockchain networks including Solana and Cardano, with Ethereum planning to join the party soon.

Here's a basic ELI5 introduction to Proof-of-Stake:

Unlike Proof-of-Work, the Proof-of-Stake system doesn't require network participants to solve cryptographic problems before adding a new block. Rather, the system relies on "validators" who stake funds for the right to confirm new blocks.

The selection of validators is one of the biggest differences between Proof-of-Work and Proof-of-Stake.

A pseudorandom process is used in Proof-of-Stake validator selection to choose who gets to validate a new set of transactions. Other factors like the size and age of the stake also influence who ends up as a validator in this system.

In a Proof-of-Stake blockchain, validators receive transaction fees, but don't get rewards for confirming blocks. As a result, there's little reason to expend excessive computing power since it's not a race-to-the-finish like Proof-of-Work systems.

Benefits of Proof-of-Stake Consensus

A Proof-of-Stake system is a better proposition for Bitcoin and other cryptocurrencies, especially if the energy consumption problem is to be solved. As explained already, the Proof-of-Stake protocol uses less energy and is considered greener.

Network participants receive rewards according to funds staked, not computing power spent on solving cryptographic equations. With regulators and the wider community questioning cryptocurrency's viability due to high energy usage, PoS may well be crypto's trump card.

But the advantages of Proof-of-Work go beyond making cryptocurrencies greener. A benefit of Proof-of-Stake systems that rarely comes up in discussions is their promotion of decentralisation.

Current Proof-of-Work mechanisms reward miners with the greatest computing power. As such, large mining collectives invest in high-grade Graphical User Interfaces (GUIs) and Application Specific Information Computing Systems (ASICS) to increase their chances of earning block rewards.

The result is a highly centralised system where a few rich individuals and organisations control access to the blockchain. Satoshi imagined the blockchain as a decentralised system, so the inherent centralisation in PoW creates problems for the future of cryptocurrencies.

In a PoS network, literally anyone can stake funds for the right to validate transactions. Plus, validators don't need expensive computers when server-grade devices will perform the task. The system is open to a larger collection of participants, which promotes decentralisation and improves network security.

Despite claims to the contrary, Proof-of-Stake improves blockchain security. In fact, PoS networks disincentivise malicious activity better than traditional Proof-of-Work consensus mechanisms.

Imagine someone tries to validate a wrong transaction to game the PoW system. While other node operators can quickly spot the problem and reject the block, the bad actor never gets punished.

With a PoS system, anyone who validates a wrong transaction risks losing money they staked. The smart contract is programmed to automatically freeze funds if malicious activity like validating bad transactions is detected.

A PoS system would also disincentivise a 51% attack. A 51% attack occurs when bad actors take over more than half (or 51%) of nodes on a blockchain. In this situation, such people can alter the blockchain ledger for nefarious purposes, like double-spending funds.

Controlling 51% of validators on a PoS blockchain requires locking up over half of the total cryptocurrencies in a smart contract. This is impractical for many reasons.

First, hackers would need to spend their money to take over the network. Second, they risk losing the money staked even if they obtain control since the smart contract automatically freezes funds of bad actors. Lastly, no one is likely to attack a system that holds 51% of their money, as it would affect the value of the currency.

Perhaps the biggest upside to adopting Proof-of-Work blockchains is the scalability they promise. For starters, a PoS network is likely to have more node operators since the barrier to entry is low.

Besides, there are no complex calculations to solve before confirming blocks—so validation of transactions is faster. This will exponentially increase the throughput on blockchains and help them scale to accept more users.

An increase in throughput is excellent for cryptocurrencies since poor scalability is a huge stumbling block to their adoption. Already, Proof-of-Stake coins like Solana and Cardano are proving popular because of their lower gas fees.

Risks of Using Proof-of-Stake in Blockchain

A section of the blockchain community, particularly Bitcoin maximalists, believe Proof-of-Stake will fail. While this view may be extreme, the disadvantages of Proof-of-Stake certainly need to be discussed.

Some believe a Proof-of-Stake blockchain is centralised because it allocates power to participants based on the quantity of the tokens they hold. As such, anyone can buy up a large amount of cryptocurrency to increase their chances of getting selected as validators.

This would end up concentrating validation capacity in a few hands, which is the same problem Proof-of-Work systems face.

Besides, PoS systems are relatively new and data on their reliability is scarce. In contrast, PoW blockchains have been the industry standard since Satoshi went live with Bitcoin in 2012.

Many also criticise Proof-of-Stake for the perceived barriers to entry it creates. This has to do with the high fees demanded by Proof-of-Stake blockchains to approve validators.

Ethereum 2.0 requires prospective validators to pay 32 ETH (around $96,000 at current market prices). Solana requires even higher fees—between 5,000 SOL and 50,000 SOL per various sources. Binance Smart Chain, which uses just 21 validators, asks for 10,000 BNB (around $4,200,000).

Still, it's important to say here that it's possible for different individuals to combine funds into a "stake pool." Stake pools allow individuals to contribute towards a particular validator and receive a share of the rewards. Services like ANKR and Rocketpool already provide these services.

Bottom Line

Is Proof-of-Stake the key to scaling cryptocurrencies and revolutionising the future of money? Yes. All the signs to the growing need for a scalable, secure, and efficient infrastructure for crypto, which Proof-of-Stake offers.

Proof-of-Stake cryptos would promote faster transactions, which may encourage more businesses to accept cryptocurrency payments. So, yes, you can now buy coffee with crypto!

More importantly, staking will improve access to blockchain networks and advance mass adoption. Even institutional investors may be willing to buy crypto now that it has long-term sustainability and better chances of mass adoption.

While it has flaws, Proof-of-Stake remains the best bet for future of cryptocurrencies. If crypto is to achieve widespread adoption, become environmentally sustainable, and scale to accept more users, moving to PoS blockchains is a no-brainer.

However, a key concern for individuals and businesses considering using blockchain technology is security. Sure, the blockchain allows for seamless transfer and receipt of assets and data—but are these transactions secure?

And it's not just CTOs and CEOs who want assurances of blockchain security. Individuals trading cryptocurrencies, NFTs, and more, want to know if their digital assets are secure.

If there's no central entity controlling and securing the decentralised ledger, then how is the blockchain secured?

That's what we're about to find out in this article.

How Do Blockchains Work?

The blockchain is a distributed ledger technology that records all transactions conducted by participants in the network. Blockchain networks are sustained by a group of computers (called nodes) distributed across the world. Each node can initiate transactions or validate new transactions, which is why blockchain networks are seen as "peer-to-peer" systems.

Not all blockchains are the same. Public blockchains like Bitcoin and Ethereum are "permissionless" since anyone with a computer and Internet connection can join the network. Private (permissioned) blockchains, however, can only be joined upon authorization by the controlling entity. Later, we'll see why the distinction in blockchain types is important for security.

Blockchain's description as a "decentralised" system comes from the absence of a single authority controlling it. In other words, every participant in the network has as much power as the next.

Each new transaction gets added to a block, which is then added to the blockchain. Once other nodes agree to the transaction's validity, the new block is added to other blocks, creating a chain—hence the name. The process of nodes agreeing to the state of each transaction is called "consensus".

How is Blockchain Security Achieved?

Blockchains are extremely secure, making them ideal for transactions requiring high levels of data integrity and safety. For example, blockchains can be used to securely transfer money, track charity donations, safeguard records, and conduct voting.

Blockchain security is achieved through a mix of cryptography, game theory, consensus mechanisms, and failure-resistant design. Let’s delve into each element to see how it contributes to securing the blockchain.

Cryptographic Hashing

Blockchains are “immutable” because they prevent the alteration of transactions on the network. These transactions could be anything from the exchange of digital assets to the transfer of digital data.

We have cryptographic hashing to thank for blockchain’s immutability and data security. Hashing involves an algorithm (a “hash function”) generating a fixed output (hash) from a data input of any size. In most blockchains, the hash is an alphanumeric string of fixed length.

Because a hash is dependent on block data, hashes serve as unique identifiers for blocks on the chain. Running the same data through the hash function will produce the same hash no matter how many times you perform the operation.

A change in a block’s data automatically triggers the generation of a new hash. Which is why it’s easy to know if a block containing transactions has been altered.

Moreover, each block’s hash contains the hash of the previous block—blockchains are described as “hash-linked lists” for this reason. Changing a block’s hash requires changing the preceding block’s hash, and the one before that, up until the first block in the chain.

Not only does rewriting blocks require massive computing power, it’s prone to failure. Other nodes will detect the alterations (each one holds a copy of the blockchain’s history) and reject the newly added blocks.

Hashing ensures funds spent in one transaction cannot be used again, preventing the “double-spending” problem in cryptocurrency. That can only happen if someone rewrote the blockchain's history—and that’s extremely difficult like we’ve seen.

Public-Key Cryptography

Beyond protecting the immutability of blockchains, cryptography is useful for safeguarding blockchain wallets. Wallets are used to store digital assets, including cryptocurrencies, non-fungible tokens (NFTs), or any other items created and transferred on the blockchain.

When users create a wallet, they get a public key and private key. The private key is to your wallet what a password is to your bank account. Every transaction must be signed with a private key to prove ownership of the assets.

The existence of a private key means that no one can gain access to your wallet and move funds and other assets without your approval. It also serves the ultimate proof of ownership since malicious actors cannot transact with assets they don't own.

Consensus Algorithms

Consensus algorithms allow participants on the blockchain to agree on the validity of transactions and the true state of the blockchain. In other words, consensus is what makes the blockchain ledger a reliable and secure record of information.

In a blockchain network, every node must confirm the validity of each transaction. This makes it harder for anyone to perform malicious activity and get away with it.

Moreover, nodes must agree on a single, shared history of the blockchain. No two versions of a blockchain can exist, making it impossible to alter records without getting noticed. Besides, controlling the consensus mechanism is made difficult by blockchain’s decentralisation and lack of a single point of failure.

Blockchain networks use different consensus mechanisms. For example, Bitcoin and Ethereum 1.0 use a Proof-of-Work system, while Ethereum 2.0, Solana, Cardano and many new blockchains use a Proof-of-Stake system.

Cryptoeconomics (Game Theory)

When Satoshi Nakamoto designed the first blockchain, there was the question of how to ensure network participants act honestly. Remember the blockchain is decentralised, meaning there's no one to wield the big stick and prevent malicious activity.

Enter cryptoeconomics.

Cryptoeconomics is based on game theory, a field of study that attempts to predict the interactions between different participants in a situation with defined rules and outcomes. When applied to blockchain networks, game theory can be used to encourage honest activity by providing adequate incentives.

Cryptoeconomics works differently depending on the blockchain. Bitcoin uses a Proof-of-Work system where nodes (called miners) must expend some resource (electricity, in this case) before confirming transactions. This rule is enforced by asking miners to solve complex equations in exchange for the right to add new transactions to the blockchain.

The computing-intensive nature of Bitcoin mining disincentivises malicious activity. Any would-be malicious actor has to spend enormous time and money (on electricity) on dishonest activity (like confirming invalid transactions). Even then, the chances of success are horribly slim.

Moreover, dishonest miners lose block rewards for confirming valid transactions. Now, our hapless hacker will waste electricity and lose money in the process of attacking the Bitcoin blockchain.

New-generation blockchains like Ethereum 2.0, Solana, and Cardano use the Proof-of-Stake system. The PoS system mirrors PoW in how it punishes bad behaviour and rewards honest activity.

Nodes must “stake” some cryptocurrency before validating transactions, which raises the barrier to entry. If nodes (called validators) confirm valid transactions, they receive cryptocurrency rewards. But should they broadcast an invalid transaction, and other nodes reject it, they lose both the staked funds and their expected rewards.

Common Blockchain Security Issues

While blockchain security is impressive, it doesn't rule out the possibility of a breach. Here are the most common threats to blockchain security:

51% Attacks

If a group of hackers manage to control a significant amount of the computing power (at least 51 percent) in a blockchain network, then they could take over the entire blockchain. Known as a 51% attack, this is the most realistic scenario in which a blockchain can be hacked in theory.

However, it's difficult to orchestrate a 51% attack for reasons we discussed under “cryptoeconomics.”Bitcoin has 15,000+ nodes (computers) running on its blockchain, while Ethereum has 2,000+ nodes. The sheer amount of resources to take over half of either network makes a 51% attack impractical and costly.

It's important to point out that Bitcoin and Ethereum benefit from a robust network. Smaller blockchains running fewer nodes are more susceptible to attacks since breaching the network requires less investment. Bitcoin SV, Ethereum Classic, Bitcoin Gold,Verge, and Vertcoin are some notable blockchains to have suffered 51% attacks in the past.

Private blockchains have a higher security risk than private blockchains because they have less participants. While controlled access improves security, an inside attacker can easily wrest control of the blockchain. This is an important consideration for companies who may be considering using private blockchains for enterprise-level transactions.

Distributed Denial-of-Service (DDoS) Attacks

A distributed denial-of-service attack happens when cybercriminals disrupt a blockchain network by overloading it with transactions. Most blockchain networks have a defined transaction limit and will crash if the limit is exceeded.

While many believe blockchain networks are immune to DDoS attacks, this is untrue. Solana is a prime example of how malicious actors can bring down a blockchain with a DDoS attack.

On September 14, 2021, the blockchain network was flooded with up to 400,000 transactions per second in a coordinated DDoS attack. Validators couldn’t keep up, causing unconfirmed transactions to clog the network and knock the system offline.

Attacks on Blockchain-Connected Systems

Outside of a 51% attack or DDoS hack, the means of attacking a blockchain are few and far in between. In fact, most of the hacks reported in the news aren't attacks on the blockchain per se.

Rather, hackers often exploit vulnerabilities at the point of contact between the blockchain and the outside world. Think third-party applications, software clients, and other means of interacting with the blockchain.

Here are some examples:

• Hot Wallet Hacks

Many attacks on cryptocurrency exchanges have targeted "hot wallets" (Internet-connected storages) used to store cryptocurrencies. Ideally, exchanges should transfer assets to a "cold wallet", which is an offline storage to protect them. But that rarely happens, making these assets ripe pickings for sophisticated crypto-thieves.

• Stolen Wallet Keys

A user's private keys could also be compromised and used to transfer assets without their knowledge. Classic tactics like phishing have proved surprisingly effective for getting users to unwittingly part with their private keys. This gives bad actors unlimited access to wallets, enabling them to steal crypto and other assets.

• Smart Contract Code Exploitation

Bugs in smart contracts can allow hackers to breach blockchain-based decentralised applications (dApps). In such cases, it's the security of the smart contract—not the blockchain itself—that's suspect. The recent Wormhole hack is a prime example of how poor smart contract code can cause problems.

Final Thoughts

Blockchains remain one of the most secure options for transferring assets and data. When the right elements—cryptography, cryptoeconomics, and consensus—are in place, breaching a blockchain network is next to impossible.

However, not all blockchains are made equal. Everything from the consensus algorithm and cryptoeconomic structure to the size of its network can impact blockchain security.

Finally, users of blockchain-connected applications like crypto exchanges and dApps must understand that these services do not benefit from the blockchain's security. Therefore, it’s important to implement other measures to make them secure.