GUEST BLOG: Bitcoin is Not Blockchain's Best Use Case by Aegis Frumento Esq

January 3, 2019

Bitcoin is Not Blockchain's Best Use Case

On January 3, 2009, the very first block of transactions -- the so-called "genesis block" -- was validated on the Bitcoin blockchain. Rarely can we date the beginning of a new thing so precisely, but we can say with certainty that today is the tenth anniversary of blockchain as a proven viable technology. Satoshi Nakamoto (whoever she, he or they are) published the whitepaper describing the Bitcoin network a couple of months earlier. But that was just an article describing a good idea. Lots of us write articles, and good ideas are a dime a dozen. To see a good idea in use, well, that's rare.

In the beginning, bitcoin, the cryptocurrency created by the Bitcoin blockchain, was hailed as the coin to rule them all. Soon, cypherpunks predicted, bitcoin would replace dollars, pounds, rubles and yens. That would leave all the money changers with nothing to do in the temples of commerce. Everything from financial institutions to nation states would soon become obsolete. Venture capitalist Naval Ravikant tweeted, "Bitcoin is a tool for freeing humanity from oligarchs and tyrants, dressed up as a get-rich-quick scheme." Maybe, but most just focused on the "get-rich-quick" part, leading naysayers like Warren Buffett, Jamie Dimon and Paul Krugman to label bitcoin a "mirage," a "fraud," and "evil." They all, on both sides of the divide, protested too much.

Amazingly, after a decade of transactions, the Bitcoin blockchain has never yet been hacked. This despite it being fully open-source; anyone can download the Bitcoin ledger and enabling software. No, bitcoin is not a mirage, and it is not a fraud. It is real. Sure, bitcoin has ranged in value from a high of close to $20,000 a year ago down to less than $4,000 this week. No doubt some of its investors were stupid and paid the price, and since when is that news? But to call bitcoin a viable alternative to dollars is a long stretch. This has nothing to do with its stomach-lurching fluctuations in value. Rather, it is because we still value bitcoin in dollars. Talk to me when it's the other way around.

Still, bitcoin has been incredibly useful for understanding what might come next. I used to think that a $10 bill in my pocket was an asset, a symbol of wealth. It's none of that, really. A $10 bill in my pocket is information -- it asserts my power to transfer, once and only once, $10 to someone else. Whether I keep it, buy something with it or give it away makes no difference. Quantity and once-only transferability are all that matter. When I transfer that $10 to someone else, I am really transferring the power to transfer it to yet another, because my transferee now has that power and I have lost it. But if that $10 bill is counterfeit or stolen, then my transferee doesn't legally have anything. Therefore, my transferee has to trust that my power to transfer is legitimate. Without that trust, I have nothing. Financial institutions and finance law exist only to validate and secure that trust.

Blockchain was intended to circumvent those trust issues by making transfers automatically valid and binding. If I owned bitcoin instead of dollars, the Bitcoin blockchain would securely verify my authentic power to transfer those bitcoin. Now ask yourself this -- what else could be characterized by quantity and once-only transferability? I don't have an answer -- or maybe I have too many answers to list. But anything that can be counted and transferred could be bitcoin by another name, and could be the subject of a blockchain application. That's what "tokenization" means, and that's what I spend a lot of my time as a securities lawyer thinking about these days on behalf of my clients.

In his talk with Andrew Ross Sorkin a few weeks back, SEC Chairman Jay Clayton said the agency was waiting to see what the "use case" of blockchain technology would be before they start micro-regulating it. Watch the 1 hour and 12 minute video of the Sorkin/Clayton interview embedded below. "Use case" is not a term I learned in English class. It comes from software engineering. It is a written or diagrammed detailed description of how a computer program interacts with a user to achieve a user's objectives. Here is one definition, applied to website design, that captures the essence of the term:

A use case is a written description of how users will perform tasks on your website. It outlines, from a user's point of view, a system's behavior as it responds to a request. Each use case is represented as a sequence of simple steps, beginning with a user's goal and ending when that goal is fulfilled.

WATCH the "Times DealBook Talks: SEC Chairman Jay Clayton with Andrew Ross Sorkin / November 29, 2018" Chairman Clayton's comments about "use case" start around 21:17: "What is the use case . . . what is the permanent  use case for anything -- that's how you look at an investment.":

But Chairman Clayton is a lawyer, not a programmer, so he really has no business talking about use cases. Yet, "use case" has entered the blockchain vernacular to mean, to those of us who are not software engineers, something like "killer app." When Professor Kevin Werbach writes, in his just out and quite good The Blockchain and the New Architecture of Trust, that "use cases for blockchain-based systems are not certain, and are likely to take longer than expected," he means to say that none of us yet knows which blockchain applications will prove to be really valuable, or when those applications will appear. And also, by necessary implication, that bitcoin ain't one of them.

It takes a lot of trial and error before a really useful application of a new technology emerges. Rarely is it the case that the first use is the best use. The internet was just a research tool for the first 20 years of its existence, and then it took another decade for it to mature into the reliable source of cat videos we know and love today. Nuclear power started as a weapon of mass destruction and did not become a commercial source of electricity until 10 years later. Now commercial nuclear power is in decline, but this week, the New Horizons spacecraft reached the farthest object in the Solar System powered by the heat of a few pounds of radioactive plutonium. So is that, 75 years later, the best "use case" for nuclear power? That seems unlikely, which means we still haven't found it.

Blockchain technology will go through a similar evolution over the next few decades. Blockchain use cases can surely make many modern transactions more efficient, but they will need to do more than that to be transformative. And "transformative" need not mean "disruptive." Walmart recently demonstrated how the source of contaminated lettuce, when tracked by a blockchain application, can be identified in seconds, when conventional tracking methods would need a week.

That works because individual groceries -- each head of lettuce in this case -- are countable things that can be transferred, so their transfer from farm to packing company to wholesaler to shipper to warehouse to store can be recorded on a blockchain as if they were bitcoin. Since the blockchain record of the last transfer embeds all prior transfers back to the original source, locating that source becomes a cinch. That's a blockchain use case that will make a transformative difference, saving lives, even though it does nothing "disruptive" to the grocery store business itself.

Many things are countable and transferable, and could be tokenized. But that doesn't mean they should be. There have to be reasons to adopt new ways to do things. The Walmart example suggests these questions: What critical need can a blockchain application satisfy better than any other alternative? What real problem can a blockchain application solve that an existing technology can't?

Blockchain technology is only a decade old today. Good ideas for use cases are a dime a dozen. Ask the right questions when you think about them. A blockchain application that protects us from contaminated lettuce is a game-changer. But to pay for that lettuce with bitcoin instead of dollars is just an affectation.


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.