Why and How to Build a Trustless Economy

Bianca Cheng

5th Nov 2020, 5:17 am

1. What is trust?

Trust is the basis of every relationship in the human society and there is no exception to business transactions. We trust each other to live up to the promise given in the first place and they are important assumptions for efficient and accurate transmission and exchange of goods, services and information. The more complex and important the business is, the more trust it requires.

For example, the chain of trust involves in the purchase of a pizza:

  • you trust that the food will not cause you diarrhoea
  • the restaurant trusts that the flour manufacturer has delivered fresh flour rather than expired ones
  • the flour manufacturer trusts that the wheat provided by the farmers is free from the poison of pesticide

This series of transactions is only possible if everyone lives up to their promises and doesn’t betray others’ trust.

Yet, we all know that it is not always the case. As a result, we have come up with rules, legal devices and regulatory bodies to make sure everyone complies with the rules. Trust between parties is of less importance as long as we believe in the medium that guarantees trust. More often, it is the intermediary who lines up and monitors the transaction. For example, I bought a dress at Zara with my VISA card. Zara doesn’t trust me to transfer them the payment, but they trust VISA in deducting the sum from my bank account and transferring the sum to that of Zara. These intermediaries replace the trust needed for a transaction to take place as they are the validator who oversees and verifies the transactions e.g. which counterparty we are dealing with and the sum of money involved.

Nonetheless, there is no free lunch in the world - intermediaries charge service fees. And sometimes, they could be rather costly. For instance, PayPal collects a minimum 3.3% service charge for any online transactions conducted via their payment gateway. Imagine your business only has a profit margin of 10%, 3.3% is a material difference. In modern society, intermediaries are no longer mere validators of identity and transaction, they are also platforms that align needs and connect business partners. Just like Uber brought the supply of idle backseats and demand for fast and specific rides together, and Airbnb connected property owners with an extra bedroom with travellers with tight budgets.

On the other hand, these intermediaries are not entirely trustworthy. There are more reported cases of data leakage by intermediaries, who sell the personal details of their users to marketing agencies for user-specific advertising campaigns. These intermediaries can also be victims of fraud and fail to spot unauthentic transaction even after doing thorough due diligence.

By this point, you might already be wondering if we can build a system that purely operates on its own based on preliminarily decided rules, that eliminates intermediaries, that cannot be tampered with, that essentially requires no trust?

Blockchain might be your answer.

2. What is blockchain?

Do not be intimidated by the technical jargon. Blockchain literally has the meaning of the two words: block and chain.

The former refers to a medium that stores information such as the sender and receiver of a love letter, or the sum of money you are saving behind your wife’s back. This block is highly encrypted in which it would be extremely difficult to interpret the content if you are not the parties involved in the transaction.

The latter refers to the system of storing and organising these blocks. Blocks are arranged one by one, in the form of a chain. Any corruption or movement of one block would disturb the rest of the chain. This is otherwise known as the immutability of blockchain technology.

Furthermore, information is decentralized since the documentation is broadcasted and distributed among the participants of that blockchain community rather than being kept in a safe under someone's bed or in the bank’s vault. In short, everyone has a copy of what is going on in the chain. Rewriting history becomes tremendously difficult when you have to go through and amend every single piece of record (or at least a majority). This system is not impossible to penetrate, yet, the cost would be unduly immense and hence undesirable to do so.

3. How does Blockchain Work in Real Life

This trustless feature of blockchain has given rise to many applications. One of the most commonly known adoptions is Smart Contract. This is an intelligent contract software which executes a set of actions or transactions when specific conditions are met. This can be illustrated with its prevalent application on crowd-funding platforms.

Say like Peter needs $100 to start a boba tea business, he wouldn’t take any sum less than this amount because he couldn’t literally start the business and he would have to return the funds collected back to those investors. The following is what would happen with the corresponding technology.

1. Without intermediary: Peter would need to knock door by door and ask if the person is interested in supporting his boba business. If yes, he would collect the money and record whom it belongs to. Shall he fail to raise more than $100, he needs to go back to the designated neighbour to return the money.

Problem: Peter is both mentally and physically exhausted because he has to go through the trouble of finding the right person as well as keeping a systematic record of the money collection. Not only is this time consuming, it might also give rise to legal claims if Peter forgot, was late or simply erred in returning the right amount of money to the right person. These investors can also change their mind where they would go back to Peter and demand for return.

2. With intermediary: Peter hired a lawyer to handle all the issues. The lawyer has a network of financial institutions who are interested in investing in boba tea businesses. He rang them and arranged the transfer of money. Peter got the money quickly and he needed not to go through the above haggles.

Problem: Peter obviously incurs a cost as he needs to pay the lawyer. Peter is also subject to the above issues - after all the lawyer happens to be a human and he can be negligent or careless in handling the money. A new issue may arise - the lawyer can be corrupted. For instance, he could keep part of the money to himself instead of acting truthfully to Peter and the investors.

3. With blockchain/ smart contract: Peter can set up a rule where the funds will only be transferred from the pool of money investors have contributed to when the $100 target is reached. Shall the amount collected falls short of the goal, the system will automatically release the money kept in the pool back to the corresponding investor.

We can see that smart contracts have made the entire process of crowdfunding faster, simpler and more secure. All parties have to act according to the rules set forth previously. No sudden change of mind. No chance of corruption. No physical or mental hazels required. The result is absolute and there is little room for error.

4. Conclusion

Blockchain technology has enabled the exchange of values without trust. It also replaces the role played by conventional intermediaries who leverage on incomplete market information to generate profits, and at the same time complements their vulnerability imposed by growing digital frauds and hackings. Blockchain technology may still be in its initial growth stage but we can definitely anticipate the rapid disruptions it will bring to our economy, business models and even the way humans interact.

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