To understand why Blockchain is often predicted to have profound impacts on our society it is necessary to understand a little bit about institutional economics. Before you cringe at the term and click elsewhere, allow me to promise to be brief with my delve into economic theory.
Institutional economics is a term coined by Douglass C. North. He makes the point that the varying perceptions among all humans leads to a distrust when it comes to how we transact. Out of this distrust comes two things.
An added cost to transact (sort of like a risk premium)
Our need for institutions to facilitate transactions and remove some distrust from the consumer
When I reference institutions, think governments, corporations and regulatory agencies. Governments define and enforce property rights, thereby lowering the cost to own and transact property. Simple enough right? Institutions act as middlemen to enable trust in the marketplace and facilitate the commerce that is key to our national income.
As a product is taken from raw material to finished good, there are added costs because one cannot be certain that the player at each step of the production process is doing things properly or honestly. As a real world example let's look at the process of purchasing organic, grass-fed steaks. A part of the increased cost is that a regulatory agency of some sort has to ensure that the farmer is taking proper care to use the correct feed and not use hormones or antibiotics. This results in an added cost burden to the consumer in exchange for the trust that the meat is organic and grass-fed.
This is where blockchain is disruptive. It has the potential to lower uncertainty and replace institutional middlemen. Blockchain technology is a decentralized database that stores a registry of assets and transactions across a peer-to-peer network.
The blockchain creates a public registry of who owns what and who transacts what. As you can see in the illustration above, the information is locked and secured through cryptography. This creates an unforgeable and immutable record of every transaction across the network that is shared with every computer in the network.
Remember our grass-fed, organic beef? With blockchain technology the uncertainty of tampering or cost-cutting is lowered because every transaction the farmer has conducted is recorded. We know if he purchases inorganic feed, antibiotics or any other suspect item. The same goes for the individuals he purchases feed from. There is less risk that they also purchase and use inorganic pesticides on the feed they give to the farmer. Less risk = less cost.
Along a horizontal production process it is currently difficult to transparently witness a product evolve over time. But with blockchain, a shared reality is created that enables non-trusting players (farmer and supermarket purchasing agent) to validate and monitor the processes for themselves.
Participants in the network such as the farmer, logistics company and supermarket purchasing agent will be able to see a real world object travel to them as it picks up value. We as consumers can see its digital signature on the blockchain until it reaches our hands. Blockchain will lead to the collapse of institutions and the need for their enforcement by lowering uncertainty and increasing trust across all levels of the production and transaction process.