One of the biggest structural challenges for digital platforms, ranging from blockchains to social networks, is figuring out how to translate the real world into a language that digital systems can process. It is one thing to build a self-contained digital ecosystem for distributing information or encoding contracts and memory. It is quite another to get those systems to talk to the rest of the world in a trusted way so that the system can be useful.
The cryptocurrency world got a stark reminder of this last week with the outcry over Tether, the stabilized coin supposedly backed one to one by U.S. dollars held in an account “off chain”—but which some say might not be. Guaranteeing the movement of tokens is far easier than guaranteeing that the tokens represent something in the real world.
This isn’t just a problem for crypto. I believe that there are broadly two paths forward for technology.
There’s the escapist path, or digital isolationism, where we create separate and competing “virtual” realities for us to retreat to alone.
Then there is the path where the digital world reflects reality and serves as a real world tool to help people better collaborate and improve the world we inhabit.
I have a preference for the latter. Let me explain.
Stable Coins and the“Tether” Problem
The recent questions around Bitfinex and Tether serve as a good illustration of the challenge of marrying the digital and the physical world.
Tether is an organization closely associated with the exchange Bitfinex, which issues a cryptocurrency USDT.
While all other cryptocurrency values have been highly volatile over the last several months, USDT has stayed very close to the value of $1 per coin. That’s because the whole idea of USDT is that it is backed one to one by dollars deposited and held in escrow.
This price-stabilized coin has played an important role recently, offering crypto speculators a safe harbor to store value when they trade out of other, more volatile, cryptocurrencies. And it has served as useful glue for those wishing to move value between different exchanges.
This isn’t a triviality for speculators. In theory, many believe that the importance of stabilized coins in the crypto ecosystem will—in time—go way beyond trading.
For instance, stabilized coins are critical for things like cryptographically guaranteed contracts on the blockchain to work properly. In contrast, if you had had your mortgage on the blockchain and priced in BTC, you would have had a heart-wrenching time over the last several months.
Price-stabilized coins should also ease the path toward real world commerce via digital tokens. We can all agree it is hard to buy a loaf of bread with a currency that tomorrow could be worth 20% more or less.
The challenge with the USDT model as a path toward stabilization, however, is the question of whether the Tether organization has been cheating by issuing new coins without U.S. dollars to back them up. That’s a worry some people have.
Blockchain technology is all about having distributed systems where you don’t need to trust any one actor—all you need to trust is math. But USDT doesn’t work unless you trust the real world organization behind it.
But there are other stabilized coin projects in the works. They follow one of three paths to bridging the digital and physical worlds.
Path No. 1—A Trusted Proxy
Tether might not be trustworthy enough to serve as a truly safe proxy. But other organizations could be—such as the U.S. government. I would argue that most people globally would trust the stability of stabilized coins if they were issued by the U.S. government on the blockchain.
This isn’t all that dissimilar to how something like the U.S. dollar became trusted in the first place. The U.S. government used precious metals like gold to back paper money. It then slowly ratcheted down the rate at which it was backed, and then fully disconnected from that backing once the paper dollar was sufficiently trusted.
It may be unlikely that the U.S. government will decide to provide the link between the physical and digital worlds anytime soon to stabilize a coin. But there are many organizations that might—smaller governments, large technology companies, etc.
And once you are proxying the value of a physical dollar with this model, it is conceivable that you could also proxy other things—like deeds of ownership for land, cars and other goods and assets—onto the blockchain. You just need an organization straddling both worlds and validating the link between a virtual tradeable “deed” and the physical property it represents.
This approach might scale poorly, but it would likely work well in the short to mid term, from a practical perspective.
Path No. 2—A Multi-Oracle World
If you don’t want to trust a single organization, why not trust a plurality of organizations and encode some logic on top of their data feeds to decide what truth is?
If you think about it, this model is appealing because it is so familiar. You might trust a single point of data for a low-risk fact. But for something that really matters, you would likely ask many trusted sources, apply your own logic, and then make a decision about what to believe.
The multi-oracle world is basically the idea that rather than trusting a single data feed or organization, a given contract encoded on the blockchain can take as input several different data feeds, and then have transparent rules encoded on the blockchain that define how to proxy between different competing versions of reality.
So, in this world, if you ask, “What time is it?” or “What is the price of the U.S. dollar?” or “What temperature is it in San Francisco?” rather than trusting a single source, you can simply say that you will talk to many sources and outline in a blockchain-based contract how you will decide between them.
This obviously has some advantages over trusting a single organization. While one is able to be corrupted, in theory, several are harder to corrupt. Further, if you encode some logic directly on top of the data you are given—for instance, it can’t be more than 150 degrees in San Francisco—you can build more trust in the link between physical reality and virtual spaces.
Path No. 3—Organizing Incentives of Many Untrusted Participants
Possibly the most sophisticated and scalable model for translating real world inputs into trustable digital facts is the market. Hayek would be tickled.
If you don’t want to trust a single proxy entity, and you don’t want to trust several physical world entities, why not try to create incentive structures to ensure participants have an interest in telling the truth?
This is what some stable-coin projects are attempting to construct in one way or another with systems of bonds, or formulas for inflation, or other ways of generating and maintaining reserves to smooth markets that rely on some level of human rationality. It is also how Augur and Gnosis—cryptocurrency projects that are building more open-ended truth prediction markets—intend to function.
And it effectively extends proof-of-stake blockchain ideas into broader questions that allow blockchains to bridge back to reality. With these staking models, a question is posed and people have a financial incentive not to lie in giving the answer.
In the simplest version of this, the question is posed and then everyone puts some sort of asset or capital at risk. A blind vote is taken, and if you vote against the majority, you lose your stake to those that were in the majority. That forces coordination at massive scale.
So, the argument goes, if you want to know the price of a U.S. dollar, or the temperature in San Francisco, all you need to do is run a sophisticated poll with a strong incentive structure not to lie. That’s an alternative to trusting any outside source.
Ideally, so long as you trust incentives and can’t corrupt everyone, this works well—and unlike the trusted proxy model, it scales well.
However, there are risks in this model. Just as democracies risk the tyranny of the majority, any voting system is open to corruption. Further, as recent history on social media demonstrates, it is easy for a crowd to believe all sorts of crazy things that run contrary to reality.
The Complexity of Trying to Consolidate Real World Trust and Identity
All three of these approaches are plausible ways to generate a class of “stabilized” coin in the coming years. Of course, creating a stabilized currency is the simplest possible “truth”—knowing the price of a dollar is a very simple version of the overall truth problem.
When we get into more complicated but useful realities for making that connection—like who has access to use real world assets, deeds and records of ownership—these models become hard to manage because they’re so sprawling and the data becomes so sparse.
Prediction markets don’t work when enough people don’t have enough first-hand knowledge to vote. Knowing which proxy or proxies to trust becomes hard, or impossible, as well.
And, of course, even more problematic, is that while there are some things nearly everyone chooses to agree are clearly right or wrong (for example, in the United States we drive on the left), most real world “facts” are more nuanced. That relativity is something human social networking can accommodate.
This leads me to believe that no matter how sophisticated digital ecosystems get, as a society, we are still going to need trusted brands like the U.S. government—and perhaps the New York Times—as sources of truth, even if “memory” of facts gets distributed.
It also implies that identity systems, where individuals make claims about each other and their views of the world, will continue to be critical off-chain for a well-functioning society.
This leaves an interesting open question about whether the push by many blockchain radicals for a globally consistent agreed upon “memory” will backfire and end up empowering big institutions that proxy truth from the real world.
Trusted Reality vs. Trusted Memory
If you think about the history of digitizations over the last several decades, the first breakthrough of digital speech and encryption was to guarantee that what Alice said could be heard by Bob without being tampered with. The breakthroughs in trust in transmission date back at least to the Second World War, and are still relevant today—sparking all sorts of power struggles between nations and technology providers like WhatsApp and Apple.
We have just seen a breakthrough that uses encryption to guarantee memory for Alice and Bob over time. Blockchain technologies allow us to trust not just what is said in real time, but ensures that our historical records can’t be tampered with or changed. This is a huge step forward, which changes the keeper-of-history role of the state and trusted centralized organizations.
But we are still waiting for the digitization of real world truth—linking the physical and digital worlds. That is going to take a currently unimaginable breakthrough to achieve, and perhaps represents, if ever achieved, the real techno-religious “singularity” moment.
In the meantime, there are two practical paths forward.
The first is to figure out some good systems for interfacing the digital and physical worlds together so we can use technology to get more efficient and help build a better real world.
The second option is that we simply give up trying to interface reality and the virtual world, and instead choose to live more and more in digital space. We’d be focused on acquiring and trading digital goods, and interacting with perfected digital characters. That is cleaner and easier to manage but lacks the nuance and opportunity of shared real world reality.
The former is my preference.