What Blockchain misses about trust
An old school framework for understanding trust
Don’t get me wrong. Blockchain, and its successor DeFi, are very promising areas with much that will go mainstream and contribute to a better financial system. But one thing they are manifestly not about is trust. Efficiency? Yes. Trust? No. Not even the best technology is infallible and, as many others have noted, trust as a social phenomena cannot be skirted. This article is a brief description of an old school framework for trust in the context of blockchain. Friends references are included for vintage charm.
The Four Pillars
Trust can be generated through
• Reputation
• Resources
• Risk transfer
• Deterrence
Reputation
Past history and conduct is an exemplary indicator of trustworthiness. Collectively, this forms a person’s reputation and is the basis behind the ubiquitous rating systems found on the web. It has also always been an important part of deciding whether to lend someone money and, in contemporary credit rating agency models, is evaluated as “willingness to pay”.
Resources
Another input into the lending decision is “ability to pay”. This looks at a person’s resources to make good on their promises. The principle here is that someone is likely to be trustworthy if they make promises that they are more likely to keep. This does not have to refer exclusively to wealth but rather a congruency between their capabilities and the nature of their promise. For example, a builder who promise to demolish an entire 5,000 sqft house in one day using only a hand-held hammer and one contractor might not be the most trustworthy.
Risk Transfer
Another way to ensure trust is to transfer the trust requirement from one person to another. Consider insurance. You might have misgivings about our optimistic builder but if he offers a job guarantee backed by an insurer you trust, you might just decide to give him a chance anyway. This is obviously an extreme example but the principle of generating trust through risk transfer is the most widely used way in which intermediaries facilitate trust. When Ross sells Phoebe 500 shares in Amazon, they execute against the stock exchange. However, the need for trust has not been mitigated but rather transferred. All the principles of reputation, resources and deterrence now need to be applied to evaluate the trustworthiness of the insurer or stock exchange.
Deterrence
Deterrence can be established through three levers
• Making it hard to cheat
• Making it easy to get caught
• Making the punishment severe
An example of the first is the principle behind watermarks on currency notes. The specialist machinery and materials required to produce counterfeit notes offers protection against cheating.
Making it easy to get caught is about creating a transparent environment that makes people of ill intent feel exposed. If done successfully, such people may just avoid the situation entirely. For example, Chandler wanted to meet at a filling station at midnight to view your old jalopy but backed out when you told him you could only make midday viewings at the open parking lot of the regional mall.
Finally, severe punishment can be a strong disincentive. If the sentence for stealing cars is death by being slowly boiled in a public square then we would judge it likely that any prospective car buyer only has good intentions.
Logically, maximizing the difficulty of cheating should be default practice but there can be cost constraints to doing so. There is much debate around the relative importance of deterring crime through ensuring wrongdoers are tried versus administering severe punishment. Broken windows policing puts the emphasis on the former but many, including proponents of the death penalty, favor the latter. For our purposes, it is enough to note that an effective deterrence system requires both. After all getting caught with no repercussions appears as useless as never getting caught no matter the severity of punishment.
Regulation
This framework of trust generation explains why intermediaries are usually regulated and highlights the principles good regulation should follow. For example, financial intermediaries are required to hold minimal financial resources, maintain operational risk controls, provide transparent reporting and hold various forms of liability insurance. They are also subject to a host of legal obligations and both the courts and regulators have the power to levy harsh punishment for misconduct. Additionally, a financial intermediary’s long term success is highly dependent on its reputation and maintaining the trust of its clients.
When blockchain is currently used to generate trust, it relies almost exclusively on making it hard to cheat. If blockchain made it impossible to cheat then, perhaps, the absence of the other trust generation elements would not matter. Although the blockchain is very secure, it is far from fool-proof. As long as blockchain is a digital representation of the physical world, there will always be points of weakness at the interface between the two. Even bitcoin, an almost entirely digital application, has an already exploited point of weakness at the point where it cannot avoid this reality. This occurs at the point where bitcoin wallets are accessed by their holders and blockchain itself has no solutions superior to existing bank technology to authorize access to these accounts.
Another potential source of blockchain trust generation is that its ledger construction makes it easy to get caught. However, those models that depend on trust generation also use anonymity meaning that it might be easy to identify when cheating has occurred but no one has really been caught. Moreover, these blockchain models currently have no central authority and no meaningful form of sanction even if one was able to unmask the perpetrator. None of this is to say such systems cannot be created and that blockchain won’t evolve, it most certainly will. The key point is that some combination of regulation, centralization and lack of anonymity is unavoidable and, even, desirable to take true advantage of blockchain technology.
Efficiency (An Ode)
The elixir of blockchain is not about trust but efficiency. A mere improvement in the efficiency of current systems may seem like a far cry from the radical promise of blockchain. Indeed, those who see that promise in political terms may well be disappointed but to view efficiency as the lifeless goal of the engineer is to misunderstand history.
Efficiency does not only mean doing the things we now do cheaper but it can also mean making a whole lot of new activities viable. A prime example of this is the motor vehicle that first appeared in the 1880s but did not become transformative until decades later when Henry Ford produced it cheap enough to accommodate mass adoption. Once this occurred, the car powered a host of economic activity that would have otherwise been unviable. These included freeing up land use outside of cities or around major train stations and creating new markets for leisure and tourism.
