The DAO: Investments Meet the Invisible Hand

A new way of running an investment fund

So, this is new. Or is it? The concept of a distributed autonomous organization (a DAO) has been talked about ever since bitcoin enabled rudimentary smart contracts. The launch of alternative cryptocurrency Ethereum pushed the chatter up several notches with their smart contract-friendly platform. And over the past week it seems that DAO-talk has become mainstream. Yet few know what they are, how they work and why they are so interesting. Because few have been put into real-world practice. And none have attracted significant public attention. Until now.

Backing up a bit, let’s briefly talk about Ethereum. Ethereum is a public distributed blockchain, similar to that of bitcoin, but with operational differences and a more intense focus on smart contracts. Its virtual currency is ether, which is used to power the mini-programs embedded in the transactions on the network. Executing a loop or completing an if-then statement will cost a certain (tiny) amount of ether. Ether can be mined as a reward for validating blocks of ether transactions, or it can be purchased on digital currency exchanges, just like bitcoin. Ether is still at a fraction of bitcoin’s market capitalization ($1.2bn vs $6.9bn), but its liquidity and value seems to be building.

A Distributed Autonomous Organization is what the name says: an organization that does not have a hierarchy, and functions pretty much on its own. No CEO, no Executive Directors, no central chain of command. Therein lies the “decentralized”. No administration staff, marketing executives or sales representatives. Therein lies the “autonomous”. There aren’t even any incorporation papers. The functions the company needs to fulfil are written in code and automatically executed when the time comes. The filing of accounts, the sending of emails, the disbursement of payments – there is no one person asking that these be done, and no one in charge of doing them. They just get done, because they are written in code. It runs itself. It exists as long as there is an internet connection.

What kind of organization can run like that, I hear you ask? Obviously relatively simple ones, such as a crowdfunding campaign (if enough money is collected, ship the product), voting (if enough votes are gathered, such-and-such happens), etc. But also more complicated scenarios have been implemented, such astransport management, content distribution, cloud storage… And even more complicated ones are possible. Just think of everything a business does, and ask yourself, how would I go about automating this?

So why have so few been put into real-world practice? Because the concept is relatively new, and the execution is risky. We can’t count on bitcoin for this (for now), as the protocol does not allow complicated scripts, and the currency’s scalability problem has not yet been overcome (although some DAOs run on topof bitcoin, which means they run off-chain but connect to the bitcoin blockchain for verifying and locking in).

Ethereum does give us that capability. With Ethereum we can program functions, with if/then/else queries and conditional responses. With Ethereum we can create all sorts of DAOs.

Such as the one launched with little fanfare at the end of April. Although often called the “Ethereum DAO” in the press, Ethereum neither owns it, nor did it develop the software. That credit goes to Slock.it, a Germany-based developer of blockchain IoT solutions. On the 30th of April they announced in their blog the activation of the confusingly named The DAO (a bit like naming your company, “The Company”), an automated association whose purpose is to invest in Ethereum applications. And they invited the community to participate by purchasing DAO tokens with Ethereum’s currency ether. DAO tokens give holders the right to vote in the investment decisions. Which makes The DAO, In effect, a crowd-sourced, crowd-run investment fund.

from the Ethereum Community Forum - DAO

In just 20 days, it has become the world’s largest crowdfunded project, by far. Up until now that honour has been held by the video game Star Citizen, which to date, as far as I know, has raised almost $110 million (the actual amount fluctuates in line with the ether exchange rate). As of this morning and with only two hours to go (the campaign ends today), The DAO had accumulated almost $130 million of ether (although this valuation fluctuates in line with ether’s exchange rate), which accounts for 15% of all ether ever mined. It also is now the most funded cryptocurrency startup ever, beating Coinbase’s $75m, Digital Asset Holding’s $60m and Blockstream’s $55m. And The DAO funds did not come from institutional investors. They came from ordinary crypto enthusiasts.

The blown-away success of the campaign has even surprised the developers. In an interview with the Wall Street Journal, Slock.it’s founder Stephen Tual said that they had hoped to raise perhaps $20 million.

What will the DAO do with the funds? Once the crowdfunding closes on the 28th of May, it will start accepting proposals from developers for their ideas for Ethereum applications, services, etc.. The token holders will then get to vote on which proposals will receive funding. The successful projects then reward The DAO with a percentage of the revenue from their deployed service (or some similar arrangement – each proposal specifies the terms of the funding and the terms of the payout).

This is similar to a VC fund, but without the VCs, without the high salaries, without the paperwork and without the interminable meetings. And, obviously, with ideas limited to projects on the Ethereum blockchain (for now).

Why has it attracted so much interest? Most of the PR has come after the fact, with headlines over the past few days heralding a new form of funding and a new way of developing. The bulk of the interest has not come from professional investors, but from the cryptocurrency community, a rapidly increasing collection of individuals all over the world that are fascinated by the potential of this new distributed consensus system.

The DAO

Yet there are increasing concerns that this may be over-blown hype. First, the legality is still dubious. Who owns the funds? Who owns the ideas? Holding tokens does not make you a shareholder, so while you can vote, you don’t technically own a share of the profits. Can The DAO be hacked? How good will an untrained “crowd” be at spotting worthwhile investments? Would it be possible for someone to buy lots of tokens and then fund their own business idea with The DAO’s money? What if the ether exchange rate crashes?

Whether The DAO ends up a success or not, it is testing new waters, and opening our eyes to what could become possible through automated transactions and governance. It is showing us the power of the community, and the interest in change. And it highlights the potential of cryptocurrencies and blockchains to show us a new way of looking at business. Whatever happens, things are about to get very interesting.

(This article was previously published on LinkedIn.)

Blockchain electricity

I’ve been doing some research recently into the role that blockchains could play in the management of supply chains. The fit seems obvious (one chain on top of another… geddit?), but it’s actually complex, and the potential impact is huge. In brief (and I’ll go into more detail in other posts), the blockchain could be used to track the progress of a good as it passes from one development stage to another. From design through to production through to shipping, with components’ information verified and embedded. Less bureaucracy, fewer middlemen, less chance of corruption, contamination or substitution. Greater transparency, lower costs. There’s a lot to talk about here.

But let’s step to one side for a moment and look at a supply chain that doesn’t move physical goods, or even digital goods. A supply chain that moves energy. The electricity grid. How can the blockchain help there?

From distributed generation to micro-supply, innovators both large and small are coming up with unusual ideas. Here are some examples:

RWE, a large German electricity producer, is working on a prototype (together with Ethereum Internet of Things specialist Slock.it) for an electric car charging station that communicates directly with your car. Your car downloads the electricity it needs, either at a plug-in station or while stationary over an induction point (such as at traffic lights), and pays exactly the right amount via its digital wallet on the blockchain. The contract is between the charging station and your car. Neither you nor the energy company need to get involved.  This system, if extended, would not only make it possible to keep your car charged in any country, since a contract with an electricity company is not needed. It also would make fleets of driverless cars more economically and logistically feasible, since responsibility for charging would fall to the car, not the owner.

Taking a huge distributed step forward, TransActive Grid (a joint venture between distributed tech company L03 Energy and Ethereum developer Consensys) can set up solar panels on your roof, and enable you to sell any excess electricity you generate to your neighbours through a “microgrid”. The aim isn’t to replace the big electricity companies, but to see if a peer-to-peer electricity network is technologically possible. At the moment the main obstacle is that these exchanges have to happen off the electricity grid, which puts physical barriers (distance) in the way of their potential spread. But if the exchange turns out to be practical, grid regulation could in the future allow adaptation of the existing electricity network. This experiment is already underway in Brooklyn, NY, and the first transaction took place successfully just a couple of weeks ago.

On the quirky end of the spectrum, SolarChange was created to reward generators of solar power, via the blockchain. For every 1Mw of green electricity produced, the producer is awarded 1 SolarCoin, which can be stored in a SolarCoin wallet and held for value appreciation, or converted into bitcoin (the current exchange rate is 0.00010001 BTC, or about 5 cents – a year ago it was a tenth of that).

solarcoin

Not as much for decentralized supply as for decentralized funding, South-Africa based Bankymoon – which develops bitcoin payment gateways for smart electricity meters – has set up Usizo, a crowdfunding platform for electricity supply. Schools are equipped with a smart meter, and donors are invited to contribute to the school’s electricity supply by sending bitcoin to the meter’s bitcoin address. Talk about a feel-good application.

Usizo - blockchain electricity

They are supported in this project by Vienna-based Grid Singularity, cofounded and led by some of Ethereum’s core team (and Bankymoon’s founder Lorien Gamaroff is a “Vision Partner”). Grid Singularity is developing a platform to use blockchain technology to connect power companies, and is exploring how to use the blockchain for smart grid management, energy trade verification and other applications. Their focus is use in developing countries, to help develop their solar energy deployment.

And as if to prove that things are warming up in the sector (there are so many opportunities for puns in this topic), just last week a potential new entrant emerged. Consensus 2016, a big bitcoin and blockchain conference organized by CoinDesk, was in full swing in New York. One of their features is a hackathon, in which ideas using the blockchain to improve lives compete for a $5,000 prize. Not a lot of money, true, but the PR isn’t bad. The winner this year is, drumroll, Decentralized Energy Utility, which aims to enable a network of smart meters and blockchain-based payments.

So, while the current electricity grid system is not about to be disrupted tomorrow, the talk about the blockchain disrupting the power supply seems to be passing from the theoretical to the practical. The potential is huge. Decentralized energy is more secure (less likelihood of power outages), involves less wastage (the power goes to where it’s needed), and once scale is reached, will save money (lower generation, distribution and maintenance costs). It also puts efficient electricity within reach of those without a bank account, even those without access to the power grid. Could we be witnessing the beginning of a fragmentation of the electricity market? How will this play out with the regulators? Could it be that the blockchain will reverse the centralization tendency of capitalism? With the stage set for the first act of a suspenseful disruption, the pre-show performance looks promising, and the cast of characters looks hopeful.

Ethereum and Bitcoin

The media seems to relish headlines proclaiming the triumph of a bitcoin rival. And it’s not surprising. Ever since the origins of theatre in ancient Greece we have been fascinated by the inevitable fall of the great and the successful, especially if at the hands of a young competitor. It makes for a very good story, in which we acknowledge the fragility of existence and console ourselves with the knowledge that everything changes. So, the recent headlines will no doubt sound like a compelling combat to the death between Ethereum and Bitcoin, with only one virtual currency emerging victorious.

But it’s not like that. I love a good headline as much as anyone, but positioning the two as competitors does each a disservice. Bitcoin will end up suffering even more blows of misunderstanding and misled scepticism. And Ethereum’s potential will get tarnished with the flimsy “just another virtual currency” brush. The reality is that both can, and should, co-exist, as each targets a different functionality.

ethereum homestead

What is Ethereum, and how is it different from Bitcoin?

It is often labelled an “altcoin” (alternate cryptocurrency), and while that is not inaccurate, it is only a small part of a very big picture. Ethereum does have its own cryptocurrency: ether. But ether is not meant to be a currency as much as it is meant to be used to facilitate Ethereum transactions. It’s complicated, but stick with me.

Glossing over Ethereum’s interesting history and parallels to early computers (which can lead to premature conclusions about its future, I’ll talk about this more another time), the most useful and novel feature is its capacity for complicated instructions. Bitcoin is what they call a “stack” script, which means it executes orders from top to bottom, but it can’t go back a few steps. It can’t loop. Ethereum can include loops, and conditions, and all sorts of cool computing functions that make it flexible and capable of executing relatively complicated sequences. Looping is especially useful for “while this, then that” and “if… then… else” instructions, which contemplate various outcomes and produce different results accordingly. Bitcoin can include “if… then” statements, but if the condition is not met, it simply moves down to the next instruction.

Bitcoin chose to not include “Turing-completeness” (the ability to execute relatively complicated programs) to avoid the possibility of infinite loops. Ethereum gets around this problem by requiring the attachment of a certain amount of “gas”, units of transaction currency which are exchangeable for ether, the official Ethereum currency. Each step in the code packet “spends” a unit of gas. This is what eliminates the problem of infinite loops. Each transaction has a certain amount of gas assigned, each step (including loops) subtracts from the gas available, and when the attached funds run out, the program crashes. End of problem.

Why not just use ether, the official Ethereum currency, to pay for the program execution? Because each function has a set cost in gas units. The exchange rate of ether will fluctuate with the market. By separating the Ethereum currency from the cost of the execution functions, the system strips out the cost volatility, which will make developers’ lives much easier. The cost of an application in gas can remain constant, it won’t need to be frequently updated. What fluctuates is how many gas an ether can buy.

This same system keeps Ethereum light. Running complex code will end up being expensive, not just in computing power and storage, but also in money terms. With each step carrying a cost, developers have a strong incentive to write tight code.

This complexity makes Ethereum ideal for blockchain-based smart contracts. You can issue currency, manage domain registrations, create an identity management system, set up a decentralized social network, program on-blockchain gambling, create Decentralized Autonomous Organizations, file crop insurance, generate financial derivatives, build a blockchain dropbox, run a P2P crowdfunding campaign, set up prediction markets, manage escrow payments, run decentralized auctions, play around with the internet of things, and much more.

A lot of this can also be done on Bitcoin. Theoretically it is possible to do pretty much anything with Bitcoin that you can with Ethereum (note the with Bitcoin, not in Bitcoin). But programming complicated smart contracts in Ethereum is easier.

If Bitcoin can be called “programmable money”, Ethereum is even more so. Only Ethereum is not about “money”. Bitcoin is. And therein lies the main difference. Unlike Bitcoin, ether is not intended to be a universal currency. It is intended to facilitate transactions. Even the Ethereum blog acknowledges the difference: “What Bitcoin does for payments, Ethereum does for anything that can be programmed.”

Ethereum is still new: it only officially launched its development platform last July, with an update released in February 2016, just over a month ago. And as such, it is still relatively untested. Yet that doesn’t seem to dampen enthusiasm. The ecosystem is growing, and includes not only techies but also musicians, artists, politicians, lawyers, sports fans…  I went to an Ethereum event recently in Madrid that ended up standing room only.

The potential of Ethereum as a platform lies in the hands of its developers, very smart people coming up with breathtaking ways of improving efficiency and adding functionality to information transfers. It also lies in the hands of non-developers who want to push the boundaries of what is possible, and to see how far we can reconfigure established ways of doing things. It’s exciting. Both Bitcoin and Ethereum are disruptive and revolutionary. Bitcoin has a longer history (all of six years!), and as a result also has a longer list of problems and obstacles. Ethereum is learning from Bitcoin’s mistakes, and is focussing on a different path, in technical and also in philosophical terms. Both will contribute to a new level of innovation that will have a material and lasting impact on how our society and our economy works. It’s not a competition. It’s a joint project, with the explicit goal of pushing boundaries. Like the Captain said: “To boldly go where no one has gone before.”

ethereum

(For more on how Bitcoin works, see Bitcoin Basics.)

Smart property: what does that mean for the blockchain?

Smart contracts enable us to use the blockchain to lock in instructions contingent on something happening. If a certain price is reached, sell. If the package arrives, pay. If someone uploads a document that contains a specific sequence of words, send that person an image. I’ve written about smart contracts before, so I won’t go into much more detail at this stage. Today I want to talk about smart property.

Smart property is an extension of smart contracts. An interesting extension that could change our relationship with objects, and push the Internet of Things into practical, interactive uses.

by Negative Spade for Unsplash
by Negative Spade for Unsplash

The idea that physical things have technology embedded in them is no longer new. We have all heard of smart lightbulbs, smart clothing and smart trashcans that gather data, transmit and occasionally talk amongst themselves. So far, most of the uses for the Internet of Things (in which objects have sensors and link to other objects) have been about collecting information and transmitting data. Smart bus stops gather statistics about public transport use in specific areas, and can keep users informed about times and routes. Smart mattresses can record sleep patterns and help to diagnose any problems. Smart cups record how much liquid you consume, and advise you how on you’re doing compared to the ideal.

Smart property contracts, however, embed decentralized blockchain technology into objects, and make the relationship more interactive. Instead of giving the objects a data-collecting life of their own, they increase our control over their use. Smart property contracts can dictate the extent of our ownership and control over networked objects. And they do so in a decentralized, efficient and automatic way.

Perhaps you have had the experience of renting a car with RFID (radio frequency identification) technology, which gives you access to a vehicle without even passing through the rental office. Efficient and very clever, it saves the user and the rental company time, and makes it easier to track the cars and their use.

The smart property concept is even more efficient, in that it unifies the rental contract and the access in one tiny piece of code. If this amount is paid, open the car door for the bearer of this sequence of characters.

It is also more revolutionary, in that it opens up the rental field to just about anybody. With the current RFID system, the business structure does not change. You still pay one of the established car rental businesses, and they decide if you get access to the car, and to which one. It’s still a centralized system in which they own the asset and they decide who gets to rent it. And it’s limited to the big players, since the investment needed to kit out fleets of cars with the necessary technology is substantial. Smart property opens up the field to individuals or small businesses. Investment in technology will be necessary, but will be limited to the lock automation and the readers. Since smart property contracts run on open-source blockchain technology, no expensive proprietary software should be needed.

The concept enables the blockchain to become a tool for managing property rights. As with cars, it could make apartment or house rental agreements more secure. Computer rentals. Bicycles. Power drills. The “sharing economy” could get a boost as the hassle of renting out items when we’re not using them is significantly reduced.

Established sectors could also benefit from the potential efficiencies. Hotels, for example: imagine not needing to pass through the check-in desk. Your public Bitcoin address becomes your room key, and payment is automatic. Access automatically expires when your departure date rolls around.

And smart property can extend the use of credit, by removing trust from the equation. Smart objects can be used as collateral. The lender can program the restriction of access to a car or a property if payments are missed. While that sounds harsh and slightly dystopian – consequences with no human intervention and no room for appeal – it would make it easier to get loans and concessions, with less risk for the loaner. Access to car loans, loans for residential or commercial rent, etc., gets opened up to a much wider potential base, with all the social and economic benefits that that implies. In theory, anyway. Obviously, legal challenges would need to be ironed out, but the business potential is sound.

Even more potentially interesting is the impact that smart property can have on business structures. By “democratising” use of property and programming conditional access, the concept could give rise to new types of group governance, decision making and rule enforcement. New types of ownership structure could develop as a result, which would lead to new types of markets. The impact of Bitcoin and the blockchain could well be even deeper than most Bitcoin enthusiasts realise.

What are smart contracts?

“Smart” is a very loaded word. According to my Google dictionary, it means “having or showing a quick-witted intelligence”. Quick-witted is not usually a word that you associate with contracts. Most of them are barely intelligible.

Unless we start to look at what we mean by “contract”. We are all familiar with pages of legalese when we want to take out a bank loan or buy a car or, god forbid, a house. Employment contract, sales contract, rent contract… Even a will or final testament is a type of contract.

by Mari Helin-Tuominen for Unsplash
by Mari Helin-Tuominen for Unsplash

We are so used to the concept of a contract being a whole lot of words, some of which we don’t understand, that we forget what it’s really for. To reduce risk. In a contract, we want to establish the conditions for a transaction, while protecting ourselves from the possibility of the other party not fulfilling their part of the bargain. Contracts not only set up the conditions for the transaction, but also what will happen if various conditions are not met, or if either side is not satisfied. Contracts are long because of the lack of trust.

Wouldn’t it be great if we could come up with a way to simplify contracts? To make the trust implicit? And while we’re at it, to remove the control of the contract from one party, and make it tamper-proof, time-stamped, and verifiable by the public? And to make it indestructible, stored on decentralized servers, away from fire/flood/failure risk?

Enter Bitcoin.

Based on a decentralized network, Bitcoin’s very philosophy solves the problem of how to transact with people or institutions that you don’t trust. And it does so with a few simple lines of code. Your Bitcoin commitments are validated by the network, then published on the blockchain for everyone to see*. They are almost impossible to tamper with, so you can’t retroactively “change your mind”.

How can this be adapted to the concept of contracts? Each Bitcoin transaction is already a very simple type of contract, in which someone promises to pay someone else in bitcoin. The only condition attached is that the transaction be valid, in that the payer actually owns the bitcoins that he or she wishes to send, and that he or she hasn’t already sent them somewhere else. If that condition is met, the “contract” is fulfilled and the bitcoins change hands.

For more complicated scenarios, the Bitcoin code does allow the insertion of if-then clauses. If this happens, then this.

“If the box arrives at its destination before Tuesday, pay me $249.49.“

“When the document has been uploaded and has 2000 words, send the images.”

“If Real Madrid wins the championship, pay me €1000.”

These are contracts. And if the condition is something that can be verified without a person or centralized authority getting involved, then the “then” part of the clause can be activated automatically. Instead of highly-paid professionals and reams of paper, you have a few lines of code that enact the same conditions in a much simpler, cheaper and faster process.

What kinds of conditions can be met without human intervention? Prices, for instance. In fact, financial contracts are one of the more interesting and practical applications of this technology. If this (a published price reaches a certain level, or a valuation is announced) happens, then pay a certain amount to someone, or transfer certain information.

Deliveries can also be verified online. Once a receipt is electronically acknowledged, pay the supplier.

Transfers of funds: once this amount enters this account, release this document.

Wills or last testaments: once the death certificate is filed online, funds can be released.

Even marketing: once this ranking in Google is reached, pay this amount.

Smart contracts are effectively self-executing agreements. This function can be used to create new financial instruments, new types of deals, even new business sectors.

They can be used on the Bitcoin protocol, or on separate platforms like Ethereum, which use blockchain technology, but don’t run on the blockchain. Ethereum doesn’t even use bitcoins, preferring their very own digital currency called ether. Ethereum is notably different from the Bitcoin protocol in that it can be fully programmed. Bitcoin’s flexibility in programming is very limited. It can include if-then functions, but that’s about it. Ethereum can include if-then, loops and a whole lot more. On Ethereum, smart contracts can get sophisticated.

Many other platforms are also working on empowering smart contracts: SmartContract, Symbiont, Ripple, Hedgy, Counterparty and Mirror are just some of the teams proposing innovative blockchain-based solutions. Several other platforms are in development, to enhance smart contract capability. This is going to get very interesting.

*There are ways to keep the information in Bitcoin- or blockchain-based contracts private. We’ll talk more about this later.

(For more on how Bitcoin works, see Bitcoin Basics.)