The 6 Major Problems With Blockchain

As an advisor to blockchain entrepreneurs, I am a huge fan of how the blockchain can disrupt many industries and change our world for the better. However, blockchain solutions aren't a panacea. In this article, I will help you step back and understand the issues and limitations that exist in the blockchain world. My objective is to help you better evaluate the ideas, companies and business problems being addressed by the blockchain to determine how to proceed (or not) with the business opportunities exposed to you.

The six major problem areas include:

1. Untested Ideas
2. Cost: Energy Consumption
3. Transaction Speed
4. Forks
5. Immutability
6. Regulation and Lack Thereof

Untested Ideas

I love entrepreneurs who propose ideas the world has never seen before. This is where amazing innovation happens, and I encourage creative, disruptive thinking. (Bring it on!) At the same time, a great idea, even if implemented well, doesn’t guarantee success. Ultimately, the market votes on whether or not your new idea will succeed.

For example, in the energy industry, several blockchain companies (e.g. Power Ledger, SunContract, etc.) are looking to disrupt the utility industry by supporting microgrids of solar panel systems whereby neighbors can supply and buy energy from each other. The concept is that if you have solar panels on your home, you may produce excess electricity. Nowadays, you can sell that back to your local utility at a price set by the local utility.

Using a blockchain-based solution, you will soon be able to sell your excess power to your neighbors. And, if you don’t have solar panels on your roof, you will be able to buy power from your neighbor that does. This sounds like a great idea to break the lock the utility company has on buying power at the prices they set. We will now have the freedom to cut out the middleman and support our neighbors. It feels almost utopian.

Except for one thing. What about that pricing?

It turns out that in most parts of the world, the utility company produces energy more cost-effectively than local solar does. The implications for the home with the excess solar is that your neighbors won’t want to buy power from you because your power is more expensive than the utility’s power. Until and unless local solar production pricing drops significantly, we just shot a huge hole in this business plan.

The idea of a market for local solar might work, but putting it on the blockchain isn’t enough. The market forces of power play a much bigger role. Evaluate the likelihood of investing in any idea by understanding the critical market forces first.

Cost: Energy Consumption

The bitcoin network has roughly 12,000 nodes working away to validate and create blocks to add to the blockchain. The amount of energy to validate bitcoin transactions is close to what Denmark consumes annually. This has an unavoidable impact on the environment and a real cost (in bitcoin) to running the network.

Any blockchain solution you create -- by definition -- will have many computers working away to manage the transactions. Every one of those computers has an environmental impact. The owners of those computers need to be paid to run their nodes on the network. This is true whether your blockchain is public or private. The most common way of paying for this energy consumption is by issuing tokens to the miners.

Paying miners has a profound impact on your token economics. You are paying (for the electricity, and fixed costs and labor) for the miners to mine your tokens. It’s critical to understand how this will play out, especially when the price of your token drops and miners no longer find the price you’re offering interesting to them.

Fortunately, people are working on many ways to alleviate this problem. Some blockchains use a Proof of Stake algorithm vs. the Proof of Work that bitcoin uses. Proof of stake hypothetically reduces the energy consumption substantially, although this remains to be seen.

Some mining data centers are being built in places like Iceland, which n addition to being cold, has cheap geothermal energy. The reduction in energy costs is good for the environment, good for the miners and good for token economics.

Transaction Processing Speed

Transaction speeds are not a problem if you’re settling a transaction in 10 minutes (like with bitcoin) vs. 3 - 5 days compared to a cross-border money transfer transaction. However, many applications require much faster transaction processing speed, and blockchain isn’t there just yet.

A common comparison point is that Visa can run at approximately 24,000 transactions per second, whereas bitcoin runs at roughly 7 transactions per second. This problem will eventually be resolved as many projects are attempting to address this specific issue.

Ripple is probably the leader at the moment. Other projects that promise transaction speeds greater than Visa include BitShares, Red Belly, EOS Kochava and recently, Ethereum. However, few if any, are actually working in production environments.

Forks

Most public blockchains (like those for Bitcoin and Ethereum) are open source projects. When developers want to change the code, they often don’t agree. If enough developers don’t agree with the majority, they may choose to fork the blockchain (create their own code going forward). This can create great uncertainty.

Bitcoin itself has been forked about 70 times. Two successful forks include Litecoin and Bitcoin Cash. The remainder have virtually no value to them because they have no users.

Forks are sometimes positive, necessary steps to update the software. An open source project can use forks for good or may have forks occur that create more confusion than value.

An even bigger issue with forks is that because your project is (likely) an open source one, anyone can take your code and use it to compete with you! You need to think carefully about what part of your code base should be open source, and what part should be proprietary.

Immutability

Immutability is a strength of the blockchain, but it is also a weakness. A recent analysis of smart contracts found that 3.5% have vulnerabilities that can be exploited. In other words, they are hackable. The blockchain itself isn’t hackable, but the smart contracts that place the data onto the blockchain may be.

What happens when a smart contract is hacked and the transaction (that can never be changed) gets recorded? In most cases, there is no recourse. For non-blockchain transactions like credit card payments, if a company makes a mistake regarding a credit card transaction of yours, you have recourse. On the public blockchain today, there is no recourse.

This will cause significant problems like in the case of a financial transaction where one party says they paid, but the other party says they didn’t receive payment.

Several companies (e.g. Kleros.io, Jury.online) have cropped up to address this issue, but it will take quite some time before this problem is fully addressed.

Regulation and Lack Thereof

The SEC, the FTC, FinCEN and the CFTC have all weighed in with how they intend to regulate cryptocurrencies. Unfortunately, while I applaud regulation for cryptocurrencies, these agencies don’t all agree with one another. That means that regulation now makes starting a blockchain company that intends to ICO riskier than it seemed only a few months ago.

As it relates to existing cryptocurrencies however, the current trading environment is virtually unregulated and that makes it very dangerous for investors. Consider pump and dump schemes for example. Here’s how they work:

• A small number of people decide to pump & dump a token
• They invite others to the inner circle of those “in the know”. However, being invited to the inner circle doesn’t guarantee you are actually in the inner circle. It’s more likely you were invited to help pump the token.
• The inner circle then promotes the token, getting the others recently invited to also promote the token.
• After a rise threshold is made, the originators get out (dump).
• Because the rise had no substance behind it, the token’s value invariably declines.
• The pumpers gain, the people invited to the inner circle may gain a little, and the HODLERs lose.

As always, when investing in cryptocurrencies -- caveat emptor.

Every new technology has advantages and disadvantages and blockchain is no different. The blockchain will disrupt many industries. It’s critical that if you get involved, you understand what can go right and what can go wrong with blockchain implementations.

Glenn Gow is Marketing Partner at Clear Ventures. He works with CEOs on their biggest challenges. He is a CEO Coach, a Board Member, and is a popular speaker and advisor on Blockchain, ICOs and Cryptocurrencies.