26 May 2022

Blockchain technology (aka “distributed ledger technology”, aka “DLT”) is a game-changer, with implications for all aspects of society and commerce. Digital assets secured on a blockchain are quick, cheap and efficient to process, while also being “smart”, secure and traceable.

But actual use cases of blockchain currently fall far short of its lofty promise. Bitcoin, for example, has been touted to replace fiat money for well over a decade now, but no cryptocurrency has even come close to threatening traditional finance. Similarly, NFTs carry enormous untapped potential for authenticating data and providing services (such as our own legal advice NFTs), but are mainly associated with a speculative market in cartoon apes.

As we stand on the brink of a second “crypto winter” (and one that’s predicted to be longer, colder and harsher than the first) it’s a good time to ask: what’s holding us back from the bright blockchain future we were promised?

The problem

The problem is chiefly the yawning gulf between theory and practice.

Although DLT works fine in theory and on a small scale, it translates less well to larger, practical applications. The so-called “blockchain trilemma” means that no system can be simultaneously scalable, decentralised and secure. At best, you can have two out of three, so scaling up a blockchain to commercial levels inevitably means more centralisation or less security.

In addition, each of DLT’s core attributes (decentralisation, transparency, trustlessness) has an “evil twin” which can come to dominate over larger applications: decentralisation can become anarchy; transparency can lead to a lack of privacy; and trustlessness can tend towards paranoia.

The solution

Centralised oversight may run counter to the libertarian ethos of blockchain, but the average user is probably more interested in security and efficiency than in anti-authoritarian principles. In the wake of numerous frauds and market shocks such as the recent Terra-Luna collapse, even hardened players are moving away from “code is law” idealism towards “we need proper regulation” pragmatism. Just like the non-digital world, it is increasingly clear that DLT operates best within a clear framework of guidance and regulation. Successful future blockchain solutions are therefore likely to be more nuanced in their attitude to such matters.

DLT is still in its embryonic stages but is maturing and expanding fast. If users can get comfortable with a reduced emphasis on decentralisation, one way for DLT to go mainstream is to be adopted by big business and national governments – ironically, just the kind of vested interests it was designed to replace.

The future of cryptocurrencies

Take cryptos as an example. While pioneer cryptocurrencies remain hugely popular, they are plagued by extreme volatility, insufficient liquidity, high transaction costs and bad actors. Bitcoin may be a fantastic vehicle for speculative gain, but it’s useless for buying your morning coffee, even in brave experiments such as El Salvador.

On the other hand, “official” cryptocurrencies (such as A$DC, launched in early 2022 by ANZ, a major Australian bank) are already appearing, pegged to national currencies and backed by traditional guarantees from banks or governments. Going further, CBDCs (“central bank digital coins”) allow fiscal policymakers to tap into the technological benefits of blockchain. Governments around the world (including Australia, China, the USA and UK) are jockeying to take the lead in shaping the future of crypto regulation and promote their own CBDC as blockchain’s de facto reserve currency.

The future of NFTs

Similarly, it may be necessary to accept some form of centralised control structure for smart contracts (and the NFTs and DAOs they underpin) to find widespread commercial application. Internal governance committees with powers to review, moderate and authenticate transactions can temper the worst excesses both of total decentralisation (by providing an arbiter to resolve disputes and deal with unintended consequences) and of total transparency (which threatens personal privacy and commercial confidentiality).

Technological innovations will also help. Zero-knowledge proofs can preserve both security and confidentiality. Higher layers of protocols riding on “foundation layer” or “layer 1” blockchains can smooth out DLT’s rougher aspects, while also offering additional functionality such as interoperability and composability.

The future of blockchain

Rather than a one-size-fits-all version of blockchain, we’re likely to see the emergence of a diverse ecosystem with different flavours of DLT. Consumers and businesses will be able to choose between the relative safety of walled gardens under some level of centralised control, or the unregulated wilds of “real” blockchains. These multiple implementations of DLT, and the various multi-layer protocols operating across them, will soon become part of everyday life, underpinning the evolution of the internet into “Web3.0”.

We can look forward to a future of blockchain where payments are regularly transacted via DLT, and where NFTs are used to guarantee the supply and integrity of real-world goods and services. Likewise, utility tokens, governance tokens, smart contracts and DAOs (“decentralised autonomous organisations”) will all contribute to cutting the amount of red tape and fraud encountered in business.

We’ll be monitoring developments in both technology and regulation throughout 2022. If you’d like to discuss any of these in more detail, please contact Graeme Fearon 07 3367 6900.

This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.

© Moulis Legal 2022