Real Talk: leverage PoW to quantify trust
By Olya Green
What’s wrong with the public trust systems?
Against the backdrop of ongoing backlash at centralized storage systems and services - banking and social security funds, in particular - there’s this one broader question - is there a better way of storing user data and assets? And, most importantly, how do we check on the performance of asset managers who move our money?
More so, if we are to assess the sustainability of modern economy and consider the staggering global debt that now amounts to USD 22 trillion, we might find it hard to maintain trust in traditional fiat systems as a whole. The financial crisis of 2008 revealed that the ‘Too Big to Fail’ was merely an empty promise backed up by virtually zero assets. Such traditional financial instruments as credit default swap (insuring the default risk of the counteragent) don’t work anymore, simply because way too much money was printed by central banks.
Oddly enough, the world of finance still operates mostly by ‘Too big to fail’ principle, which gives banks tremendous capabilities to exploit and misuse their powers. Looking at the notorious example of banking crisis in Cyprus, it’s pretty clear that the instances of fraud with beneficiaries’ funds span across strong and developing economies alike causing tremendous losses for millions of people. The problem is that despite being heavily regulated, the key financial players (banks, insurance companies, brokers, etc.) are still black boxes seen by bad actors as vehicles for money laundering, which ultimately makes their clients exposed to millions of risks covered within the insurance frameworks established by the regulator. Another issue is the nature of fiat economy that by design operates relative, but not absolute values: a client’s deposit is essentially a bank’s debt, and clients don’t own their money, if the bank stops operating. This puts bank clients in an extremely underprotected position.
However, now with the ongoing rise of #DeFi, we might have a viable alternative to the flawed financial systems of the past.
How the Internet and the emergence of Web3 revolutionized finance
The advent of the Internet and Web3 as its latest iteration has now enabled us to transmit value and dispose of our assets in a complete opposite way. By giving access to massive amounts of data online, not only did it deprive the all-mighty hedge funds of their power to arbitrage information, but also democratized finance, especially in the sense of offering new ways to transfer and track funds in a trustless mode.
Unlike banks and hedge funds that hold custody of beneficiary’s funds, digital tokens are non-custodial, i.e. we hold and dispose of our BTC, ETH, DAI, EURS, etc. independently bearing all the associated risks. Hence, the ongoing tokenization of assets, i.e. putting stocks and bonds on the public blockchain register, is indeed the culmination of the ongoing major shift in value transfer mode. Essentially, decentralized asset management comes down to putting conventional financial primitives on the newly built tech stack. Yet, compared to the centralized solutions of the past, crypto financial primitives - apart from being fraud-proof (all actions are controlled by the code with no human manager involved) and transparent - are much more interoperable with one another.
Blockchain as a powerful tool to calculate the level of financial risk
For the first time in history, the blockchain tech with its PoW consensus mechanism makes it possible to re-imagine how we estimate banking risks and presents a viable alternative to the existing systems of insurance. Unlike systems of centralized data storage that are very vulnerable by design (normally run by IT admins who can be easily compromised), these decentralized systems enable beneficiaries to calculate the level of trust / risk of the counteragent, i.e. to quantify trust. This is how it works.
Just like in a bank, there are malicious actors on the chain who might attempt to misspend your crypto funds. However, unlike banks, blockchain’s governance with PoW consensus mechanism is way harder to be interfered with, because leading a 51% attack requires more hashing power than the rest of the network. The level of trust to PoW system is directly proportional to the network’s hash rate: the higher the hashrate, the better it protects the network, as new attacks need more capital and hardware, which is hardly plausible task that requires unlimited production of computer chips within a short time frame. Hence, this PoW operating principle allows for evaluation of security of public blockchains built to manage beneficiary’s funds in a decentralized mode. Take for instance Ethereum Classic (ETC) that theoretically can be easily attacked by a 51% attack, should only the 10% of hashing capabilities of Ethereum ETH simultaneously switch to Ethereum ETC (ETC~12 TH/s, ETC~175 TH/s)
To conclude, by utilizing a PoW consensus mechanism on-chain, we can build resilient asset management systems resistant to attacks with easily assessable trust levels.