Top 10 Most Common Critiques of Blockchain

Part 3 of the Crypto Primer

The most ardent critics of blockchain technology are also usually the one’s who understand it the least. Whether you’re a diehard believer or a sceptic, this is a must-read for anyone who wants to have an informed conversation about crypto.

1 — It’s a bubble, just like the tulip bulb mania in the Netherlands in the 1600s. It’s got zero value. — Warren Buffet, Nassim Taleb, Bill Maher, and countless others

An economic bubble occurs when “the price of an asset greatly exceeds its intrinsic value”. It is undeniable that cryptocurrencies have gone through bubbles and will continue to do so in the future. For example, in 2017, the price of Ethereum appreciated 13,260% in only 12 months. After peaking at approximately $1,336 in January 2018, it had dropped back down to $157 a year later. The dislocation between the value that blockchain protocols like Ethereum can produce, and the value the market attributes to these protocols will ebb and flow. Cryptocurrencies benefit and suffer from being simultaneously both really exciting and difficult to understand. This results in an environment where there are no benchmarks for valuation. Much of the nascent price history of cryptocurrencies has been dominated by speculators, causing high volatility.

But plenty of revolutionary technologies, now broadly recognized as valuable, also experienced bubbles when they were new. In the 1840s, Great Britain was swept up in a “Railway Mania”, when Britain’s emerging middle-class speculated on railroad companies proposing to build an incredible cumulative 15,000 kilometers of line. By 1846 the bubble had burst, and many households lost their savings. In the late 1990s, America experienced the dot-com bubble and subsequent crash. In those heady days of the early internet, many companies were established to promote new services on the growing network. Companies attracted insane valuations, many of whom doing so simply by adding “.com” to their name. Pets.com famously peaked at $300 million in market capitalization on revenues of just $619,000, and $11.8 million in advertising. And yet, despite the bubbles, railroads eventually helped herald the industrial age, and the internet gave us the likes of Amazon, Google and Alibaba.

The problem with comparisons to the tulip bulb mania is the false implication that there is no economic utility to cryptocurrencies. Tulip bulbs had no use in medicine, food, or manufacturing. The flowers that grew from them were pretty. They made gardens look nice. There is no rational argument for pricing a tulip bulb higher than a house. This is where the analogy breaks down. There is huge economic utility to cryptocurrencies, which this report will explore. A better analogy to help understand the blockchain revolution is thus the exuberance of the dot-com era. If nothing else, just remember “1999 San Francisco, not 1636 Amsterdam”.

2 — How can something that’s digital be scarce?

The internet has enabled the easy transmission, replication, and storage of digital data. Music, for example, can be copied infinitely with near-zero marginal cost, leaving record companies to play whack-a-mole in a bid to enforce intellectual property rights. It is increasingly hard to sell an album for $9.99 when one can find it for free with little technical expertise.

Economic theory teaches us that relative scarcity drives value. In general, the scarcer a good is perceived to be, the more valuable it is. Examples of scarce goods include gold, diamonds, and limited-edition Supreme merchandise (though for the life of me, I can’t get behind the hypebeast trend).

Distributed ledgers are the key to the scarcity that Bitcoin and Ethereum enjoy. Thousands of nodes around the world, each holding a record of every balance and transaction, collectively come to a consensus around who owns what. Each coin can be immutably linked to its owner who has full control over it until it is sold or transferred to someone else. While the code that Bitcoin relies upon could easily be copied and executed, the nodes that validate the blockchain would not recognize this as a valid transaction or assertion of ownership. In short, decentralized autonomous ledgers enable provable scarcity.

Along with proving ownership, blockchains can limit the issuance of virtual goods by scheduling it over a particular time frame. Only 21 million Bitcoins can ever be mined, and the rate at which new Bitcoins are created halves on a set schedule, meaning this limit will be approached asymptotically.

3 — Who controls it? How can there be no governing body/no oversight?

Bitcoin was founded by the pseudonymous Satoshi Nakamoto in early 2009. They wrote much of the original software for the protocol and mined its first blocks. Satoshi is, however, apparently no longer active in the Bitcoin community. Even if they were, they’d have no control over their creation. Once a blockchain protocol is put out into the world, it will continue to exist as long as it has nodes and miners supporting it.

It can be difficult to understand how blockchain technology can function without centralized direction. Both Bitcoin and Ethereum are open-source projects, meaning that anyone can access and change the code as they please. So then, how could a blockchain function? Wouldn’t someone change the rules so they can accrue value to themselves? Critically, just because someone makes a change to the Bitcoin protocol, it doesn’t mean the change will be adopted. It is the decentralized community of miners and nodes around the world who choose which proposal to follow. The founder of Ethereum, Vitalik Buterin, remains a key player in its development, but his proposals can be adopted or rejected just like anyone else’s.

Let’s say that Buterin proposes to increase block sizes by a factor of two. 95% of miners like the idea and adopt the new software. 5% do not think it is in their interest or that of the greater community, and so they stick to the original. This 95/5 split results in a “fork”, after which there are now two separate blockchains that diverge. Neither is now compatible with the other, nor will be again. If the change is good in the long term for Ethereum, outsized value will accrue to those who followed the update. The small 5% of miners who chose to not proceed with the update then mine an “orphan chain”, which can suffer from insecurity and a lack of liquidity. This incentivizes miners to update to the newest protocol and run compatible software.

There are plenty of examples of successful open-source projects. The most famous is the operating system Linux, which was created in 1991. The majority of the world’s web servers run Linux. The development of Linux is supported by the Linux Foundation, a non-profit which coordinates funding for innovation and supports the ecosystem. Cryptocurrency projects like Bitcoin, Ethereum, and Solana have all established foundations in a similar fashion.

Open-source systems can out-innovate closed systems by a big margin, but they do have stumbling blocks. A lack of centralized leadership can result in paralysis over what direction to innovate in. The Bitcoin community for example has proven highly conservative when it comes to changing how the Bitcoin protocol functions. This provides Bitcoin predictability, which is perhaps a worthy trade-off over innovation if all it wants to be is a store of value.

Ethereum’s community has proven much more open to progress. Despite disagreements among core developers which slowed development, a big update called Ethereum 2.0 is finally underway. Assuming the cats (developers) can be herded in the right direction on key issues, open systems can fundamentally outcompete closed ones. The explosion of applications built in a permissionless fashion on top of Ethereum, ranging from Decentralized Exchanges to Decentralized Finance to Non-Fungible Tokens, are a testament to this.

4 — Environmental impact of the network’s electricity demands

When someone wants to perform a transaction on the Bitcoin or Ethereum blockchains, such as sending BTC or ETH to a friend, miners around the world compete to solve complex math problems called hashes. The first miner to find the right solution, which is hard to produce but easy to check, validates the transaction and is rewarded some Bitcoin or Ether in compensation. This process is called Proof-of-Work (PoW) and is the backbone of how consensus is established on early blockchain protocols. The computers that miners use to solve these math problems consume a lot of electricity in the process. According to The University of Cambridge Bitcoin Electricity Consumption Index, Bitcoin consumes 113 TWh of electricity per year. To put that into perspective, the entirety of the Netherlands consumes only 110 TWh annually.

This wouldn’t be a huge problem if the electricity consumed by the network was produced from renewable sources like wind and hydro. This is unfortunately not the case. Up to 75% of the world’s hash rate capacity is in China, a country which produces 57.5% of its electricity with coal.

However, there are other, newer ways to secure blockchain networks besides Proof-of-Work. Proof-of-Stake (PoS) is a protocol which attributes mining power to the proportion of coins held by a miner, as opposed to how much computing capacity that they’re bringing to the table. Proof of Work miners are incentivized to support the network faithfully since they want a continued return on the investment they’ve made in computer hardware. Likewise, Proof-of-Stake miners have a vested interest in validating the blockchain faithfully because if they compromised the network, the value of their staked Ethereum would depreciate. Proof-of-Stake removes the need for complex mathematical computations for use as a proof mechanism. Without the need to answer energy intensive Proof-of-Work puzzles, Proof-of-Stake requires a tiny fraction of the energy to run. The Ethereum network is planning to transition from PoW to PoS at the end of 2021, which by one estimate will cut its energy consumption by 99.5%. There are also further security benefits to PoS which will be explored later.

5 — What if quantum computing advances to the point where the cryptography that cryptocurrencies use can be broken?

The goal of encryption is to scramble data so that it is impossible to read, unless you are the intended recipient. All of the private information that is sent over the internet (through https) relies on one numerical phenomenon; it is really difficult to take a very large non-prime number and find its factors using a normal computer. However, a quantum computer using something called Shor’s Algorithm could do this much more easily. This represents a threat to not only cryptocurrencies, which rely on potentially vulnerable elliptical curve cryptography, but much of modern life. Most of the cryptography used today by governments, militaries, banks, and other corporations is vulnerable to advances in quantum computing. Thankfully, contemporary quantum computers need to have around 2000x more memory to factor even some of the smallest numbers used in modern encryption.

Nevertheless, this means that should a group secretly possess a quantum computer far more powerful than what is thought to exist, it would have much juicer targets than cryptocurrencies. Trillions of dollars flow through electronic networks protected with encryption, as opposed to the billions worth of cryptocurrencies.

What’s more, protocols like Ethereum already have plans in the coming years to move away from elliptical curve cryptography and into zk-STARKs (Zero Knowledge Scalable Transparent Arguments of Knowledge). Zk-STARKs are thought to be highly resistant to quantum computing. The cryptocurrency space is much more aware of, and prepared for, a post-quantum computing future than almost any other sector.

6 — What if the government shuts it down? What if it gets hacked?

Even if quantum computing doesn’t prove an existential problem for blockchains, there are still other ways governments or hacker groups could attack their networks. Any attack on blockchain networks would target one of two things — their availability, or their integrity.

An attack on Bitcoin or Ethereum’s availability would aim to deny users’ access to the network either when they want it or at an acceptable response speed. This can be attempted through a Distributed Denial of Service (DDoS) attack. In a DDoS attack, so many fraudulent transactions are sent to a server that it cannot get to processing the valid ones.

The software Bitcoin runs on has many protections to deter DDoS attacks. Additionally, it would be very difficult to overwhelm a critical majority of the 10,000 or so nodes that comprise the Bitcoin network. Blockchain’s decentralization gives it a huge advantage over centralized systems in dealing with DDoS attacks. Should a few nodes become overwhelmed, many of the remainder can continue to process transactions. They can then convey any missed information to affected nodes once the attack is over. Banks, companies, and governments that use centralized systems are arguably much more vulnerable to DDoS attacks.

Hackers could alternatively try to attack a blockchain network’s integrity — the legitimacy of the data different nodes hold. The most likely integrity attack is a Sybil attack, also known in this context as a “51% attack”. A Sybil attack is “is an attempt to control a peer network by creating multiple fake identities”. To other actors, these false identities all appear as unique users, where in reality they are one entity trying to influence the network. This bad actor could then take down the system from within by rewriting the distributed public ledger via majority control. Whether the goal is to steal Bitcoin or simply destroy people’s trust in the system, a successful 51% attack would be catastrophic.

In practice, a 51% attack on a Proof-of-Work network would require someone to control 51% of the hash rate performed by miners, either with their own computers or through someone else’s. As the Bitcoin and Ethereum networks have grown, 51% attacks have become much more expensive to pull off. A recent estimate put the costs of buying enough mining hardware to overwhelm the network at $5.46 billion. This limits this option to large nation states. However, severe semiconductor supply constraints mean this amount of computing power can’t simply be bought off the shelf with the swipe of a federal credit card.

Would-be hackers/governments could alternatively use someone else’s computing power. They could either rent it out through cloud mining contracts or seize control of the hash rate within their borders. Since 75% of hash capacity is in China, this presents an existential threat to Proof-of-Work blockchains like Bitcoin (though this risk will decline as more miners leave the country in response to new bans). Lucky for chains like Ethereum, Proof-of-Stake is both much more decentralized and would be much more difficult to gain 51% control over. An attacker would have to purchase 51% worth of staked ETH, which would cost billions if not trillions, as the process of buying that much ETH would drive prices up.

Upon closer inspection, it appears highly unlikely a nation state even as powerful as the United States or China could shut down large blockchain networks, especially those running on Proof-of-Stake consensus mechanisms. Hacks in the cryptocurrency space will continue to grab headlines, but they have yet to successfully affect the base protocol of either Ethereum or Bitcoin. All of the successful hacks in their histories concern either centralized exchanges, such as Mt. Gox, or the stealing of private keys used to access wallets.

7 — What if the government makes it illegal?

While it is unlikely governments can shut down cryptocurrency networks, they still have a huge incentive to try and control them as best they can. This is because cryptocurrencies challenge some of the key tenets of government power — namely taxation, monetary sovereignty, and economic and financial stability. The infrastructure for tracking and collecting taxes on traditional banking rails is very established, whereas crypto is the Wild West right now. Countries with capital controls, which regulate the flow of money in and out of a jurisdiction, are worried about the capital flight cryptocurrencies could enable. Governments are also concerned with the volatility that cryptocurrencies have displayed in their ten or so years of infancy, and how this could impact the economy.

As Vitalik Buterin says, governments “have a lot of power to make it more painful to participate in the crypto sector”. The wide span of tools at their disposal range from regulatory barriers to full illegalization. Let’s take a look at three different approaches governments can take.

Non-Legal Tender

The lightest touch approach, as taken by Turkey, is to ban the use of cryptocurrencies for purchases of non-crypto goods and services, or in other words to not recognize it as legal tender. Contracts denominated in cryptocurrencies have been deemed unenforceable. It should be noted that Turkey still allows citizens to hold and trade cryptocurrencies. The enactment of this law came in April 2021 as Turkey was struggling to prop up the value of the Lira amid economic woes, inflation, and schizophrenic central bank policy. This kind of ruling actually does little to diminish the value proposition of cryptocurrencies. Tons of value creation can be done within cryptocurrency ecosystems alone. Sufficiently complex and secure smart contracts don’t need to rely on an external legal framework to function.

Regulatory Barriers

Another “soft ban” could result from legislation barring financial services and payment firms from participating in the registration, trading, clearing, or settlement of cryptocurrencies. In jurisdictions with these laws, exchanges like Coinbase and Binance cannot operate. China’s recent crackdown follows this approach. This kind of ruling makes it much more difficult for the average person to break into the crypto space.

Outright Illegalization

Governments could go nuclear and simply make it illegal to own, trade or interact with cryptocurrencies with the very real threat of jail time. Precedent for something like this does exist in American history. In 1933, when the US was suffering with gold hoarding at the peak of the Great Depression, President Roosevelt signed Executive Order 6102, which outlawed the private possession of gold. If the US repeated this ruling with cryptocurrencies, Bitcoin and Ethereum’s value would likely implode. While their networks would continue to function, activity would be pushed underground, and developer activity would take a nosedive.

Thankfully, the nuclear option is looking less and less likely in the majority of countries around the world. While China was never going to accommodate the amount of disintermediation that blockchain brings with it, other important economies like India and the United States have indicated a recent shift in stance from bans and barriers to regulation and taxation. This claim will be explored further in the Regulation section of this series.

8 — It’s used by criminals and terrorists for money laundering and the funding of illicit activities.

Bitcoin was identified early in its life by mainstream media as the transaction medium of choice for users of Silk Road, a dark web marketplace for illegal goods and services. According to Chainalysis, a cyber-security firm that helps governments perform financial forensics, Silk Road accounted for nearly 20% of total Bitcoin economic activity at its peak in 2013.

To this day, cryptocurrencies remain the medium of choice for ransomware attacks — hacking attacks where victims’ files are locked up or leaked publicly unless money is paid. According to The Economist, the amount paid in Bitcoin ransoms increased by 311% last year compared with 2019, to around $350 million. Ransomware criminals like Bitcoin because it is very liquid and less traceable than traditional electronic banking. Even so, while it may be easier for criminals to move Bitcoin around, transferring it into hard fiat remains difficult. The hackers who recently ransomed Colonial Pipeline had their funds seized by the FBI when they tried to launder them through a centralized exchange.

An important distinction to note is that cryptocurrencies are pseudonymous, not anonymous. Despite Bitcoin’s highly publicized criminal use, blockchains are actually pretty ineffective places to transact anonymously. This is because as Brendan Eich, founder of Brave Browser puts it, doing things on the blockchain and being private are at odds. As we learned earlier, every node in the network has a complete copy of everyone’s balances and transactions. It is inherently public. What’s more is that over time, companies like Chainalysis can figure out the real-world identity behind most wallet addresses from the digital fingerprint left behind by regular use.

Cash remains a much better way to pay for illegal things untraceably. According to the UN, it is estimated that between 2% and 5% of global GDP ($1.6 to $4 trillion) annually is connected with money laundering and illicit activity. According to Chainalysis, in 2019, criminal activity represented only 2.1% of all cryptocurrency transaction volume (roughly $21.4 billion worth of transfers). In 2020, the criminal share of all cryptocurrency activity fell to just 0.34% ($10.0 billion in transaction volume). This means that fiat currency is still the tender of choice for criminals and the share of cryptocurrencies used in illegal transactions is going down year by year. Cash is king, as it were.

9 — Blockchain is an “extremely inefficient way of conducting transactions.” — Janet Yellen, Treasury Secretary

Transactions on the blockchain are settled every time a new block is finished and agreed upon by validators. Bitcoin finishes blocks approximately every 10 minutes, with an average of 1800 transactions per block. Ethereum finishes a block every 13 seconds, with each block containing approximately 70 transactions. Transactions are facilitated by miners and paid for by the sender with a small amount of currency known as a “gas fee”.

At current levels of use, the Ethereum network’s capacity is hugely outstripped by demand. This mismatch is addressed by a “first price auction”, whereby each sender submits a bid, known as a gas limit, for how much they’re willing to pay. The higher the gas fee, the greater priority miners will give to that transaction, facilitating it more quickly.

Gas fees have spiked dramatically on the Ethereum network in the last 12 months. In February 2021, gas fees on the decentralized exchange UniSwap were north of $USD40. Since gas fees are flat regardless of the amount sent in a transaction, this dynamic can make small-scale use of Decentralized Finance (DeFi) infeasible. As Treasury Secretary Janet Yellen has pointed out, this also serves as a big barrier to the wider adoption of blockchain protocols. At the level of transaction throughput outlined above, blockchain could never compete with payment providers like Visa, whose credit cards are used around 2000 times per second. The NASDAQ routinely handles over 250,000 transactions per second.

Thankfully, there are a number of scaling solutions on the near-term horizon. Ethereum 2.0, the roll out of which is ongoing, will introduce something called sharding, which should help dramatically. Since Ethereum 2.0 is an update to the base protocol of Ethereum, it is considered a “Layer 1 Scaling Solution”. Other innovations such as Polygon (formerly Matic) sit on top of Ethereum’s layer one and use things like Optimistic Rollups and zk Rollups to increase capacity. These “Layer 2 Scaling Solutions” used in combination with sharding could increase volume to 100,000+ transactions per second.

Other blockchain protocols, which were started after Bitcoin and Ethereum, and could thus learn from their mistakes, are already there. Solana, for example, can handle up to 50,000 transactions per second. Transaction capacity is a major dimension of competition between different protocols and will play a big role in which ones come out on top.

10 — How can my privacy be protected?

In response to Critique #7, we learned that blockchains are by their nature non-private. For the network to agree on who owns what, each node must have a record of the balances in each wallet. Cryptocurrencies remain pseudonymous in theory, as long as you do not disclose your ownership of a wallet to other entities. As a result, if you are concerned about people knowing how much crypto you hold, you can’t give your main wallet ID to a friend so they can pay you back for some beers.

There are a number of ways to get around this. One is to have a wallet for investing, which holds the majority of your funds, and which you do not disclose to third parties that can associate it with you. The activities that you undertake on this wallet like participating in DeFi or trading will stay pseudonymous. You can then have another wallet that holds funds for day-to-day transactions.

It is important to note that most people getting into the crypto space will trade their fiat for cryptocurrencies on a centralized exchange. While you can then send these funds to your own self-custodial wallet afterwards, Coinbase for example could probably infer that you own this other wallet. You would trust Coinbase, like you trust other financial service providers, to keep this information safe and secure.

There are also exciting innovations in privacy known as shielded identity or identity escrow. Privacy preserving protocols like AZTEC create a blind signature certificate that lets you transact anonymously. At the same time, there is a proof baked in that blind signature certificate that allows for identity verification for KYC purposes. In the event that you do something illegal, a subpoena can uncover an audit trail.