Abstract: Distributed ledger is a revolutionary ledger based on the establishment of a digital database, which is a kind of third-party accounting and ledger sharing. Distributed ledger will greatly reduce transaction costs, and it has network effect, which means the value of the network will increase exponentially with the growth of nodes. There are many advantages of distributed ledger, such as being easy to open an account, programmable and intelligent. No third-party endorsement and no permission are required to open an account. Decentralized accounting is more benefit to risk management. Accounts truly achieve the principle of penetration with the data being not tampered forever. Digital currency also has the same characteristics, such as disintermediation, programmability and high friction-free efficiency. When such a set of digital currency is issued based on the blockchain, a new business model will be opened up.
The most basic and core economic relationship among people is transaction. Relying on accounting methods and account system enables us to deal with complex transaction activities quickly, efficiently and cheaply. In the real economy, the most basic account system for everyone is the bank account, on which come the pension account, insurance account, securities account, and even the Internet wallet account. But these are all based on the bank account system. Since 2009, there has been a new accounting method and based on a new account system, the emergence of new units of account — digital currency, distributed ledger and encryption accounts.
This change is disruptive and revolutionary that brings out the emergence of many new financial and economic trading models.
The historical evolution of the ledger
For the past 500 years, humans have used a system of double-entry bookkeeping. If you have read Shakespeare’s play，the Merchant of Venice, you know that during the Renaissance, Italy developed into a global trading center because of its special geographical position — the eastern shore of the Mediterranean Sea. Italy has a lot of transnational, trans-continental trade with the places of the Middle East and Asia through the Mediterranean. Even today, transnational and trans-continental trade is still very complex, which needs the demand for complicated financial services. In 1594, an Italian mathematician summed up double-entry bookkeeping based on the continuous innovation on accounting method of the merchants of Venice in the Renaissance. The first modern bank was established in Venice, whose background of establishment is based on its role in global trade and the prerequisites for the creation of double-entry bookkeeping. Double-entry bookkeeping is still within its framework.
In China, people in the end of Qing dynasty used running account. So, what is the running account? It is a method of recording income and expenses from trade instead of liabilities. In recent years, several large private Chinese companies have had problems. Although there are many reasons for their problems, one of them is that there is no difference between debt and equity in the eyes of enterprise operators. They think that as long as money goes into the company’s accounts, it’s going to be the company’s assets, so these companies are generally highly leveraged. For those who do not have double-entry bookkeeping and the concepts of “asset side” and “liabilities side”, they do not know that their liabilities are already at a very high level. This is why modern business or modern financial services will not come into being in China. In the late Qing Dynasty, there were exchange shops and money houses. When modern banking industry entered China, these traditional exchange shops and money houses lost their competitiveness. The important reason is that they could only record income and expense. The greatest feature of double-entry bookkeeping is that it balances debits, credits, assets, liabilities, income and expenses.
Background and features of the distributed ledger
As we all know, distributed ledger is a revolutionary and disruptive ledger, why?
First of all, distributed ledger is built on the establishment of a distributed database, recording digital packets instead of a simple series of numbers. Secondly, the bookkeeping method belongs to the third-party bookkeeping (we all know double-entry bookkeeping is to keep their own accounts). Thirdly, shared bookkeeping means each person keeps his or her own account in a ledger and shares account information. Finally, it is a ledger with comprehensive information including the capital flow and the information flow, in which everything can be recorded together.
The background of distributed ledger can be called “digital migration”. In short, human society is moving from industrial society to information society, from physical space to information space. As we move into digital space, we need to reconstruct a digital world. And we’re now going from the atomic situation to the BitCoin situation, from the low dimension to the high dimension.
What is the transition from the low dimension to the high dimension? There are two striking cases in China. One is take-out food industry. There is a joke on the Internet that “it is take-out food, not Uni-President instant noodles that beats Master Kong instant noodles”. Instant noodles are no longer an option when you can order delicious food from different countries and regions within half an hour in your home. As a result, sales of instant noodles have plummeted. But the people who created take-out food by Internet don’t want to compete with instant noodles companies. They just stood in a higher dimension. In another case, “it was not the police who defeated the thieves, but the mobile phone payment”. Now many Chinese people do not put money in their pockets, so there has been a great impact on the thieves. The original intention of Alipay and WeChat payment is not to fight against thieves, but to eliminate backward things in the old world after the establishment of business model in a higher dimension. This is the background of distributed ledger.
As we rebuild such a digital economy in the digital world, we need new methods of bookkeeping and new systems of account, even new units of account. The existing system is no longer sufficient to complete the reconstruction of a new set of economies in a higher dimension of the digital world.
The migration from the industrial society to the information society has led to the emergence of some new rules and regulations in the economy. Over the past few years, a number of observers and economists have summarized the situation, such as the chief economist of Google, who wrote a book called The Information Rules, and Kevin Kelly’s New Rules For The New Economy.
Changes brought about by distributed ledger
In terms of transaction costs, the marginal cost is zero. Transaction cost theory is a subject of economics, which is the foundation of the construction of modern enterprise system. Because we need to use company (the organizational form) to internalize a certain part of the market process into the internal process of the enterprise, so as to reduce the transaction cost. So the enterprise is necessary to exist. The purpose of the existence of enterprises is that the internal cost must be lower than the market cost. If not, there is no need for enterprises to exist. But when the marginal cost is zero, do we still need companies? I guess probably not.
There is a book called The Zero Marginal Cost Society. “Zero margin” can only be achieved in the digital world. In the past, if we want to share a song, we had to cut 10,000 CDS to 10,000 people. When it comes to atoms and physical states, the marginal cost has to go up. But the marginal cost of sharing a song over the Internet for 10,000 people is zero. Zero marginal cost directly leads to the query of the existence value created by enterprise. In the blockchain world, there are few centralized business organizations. For example, all intellectual property rights of BitCoin blockchain are open source without shareholders’ meeting, board of directors, employees, offices, operating revenue, etc. We do not know in which country or sovereign area such a purely decentralized business system is registered. It does not belong to anyone, or even don’t know the people who created is male or female.
In traditional economy, creating a project whose founder is unknown is almost unthinkable, so autonomous organizations and autonomous governance in the digital world will become a common economic organization. There are no stock rights, being unable to raise funds in the form of stock, so we began to use Token which represents some right of use. This is the source of ICO. The entire digital economy is driven by algorithms. It no longer relies on the board of directors and shareholders to vote and make decisions. There is no RH department, finance department or offices, but the algorithms as rules.
Not only the BitCoin blockchain, the whole blockchain is composed of a whole set of algorithms, such as asymmetric encryption algorithm, hash, zero knowledge proof, etc. Different algorithms have different purposes. In fact, a set of algorithms drives artificial intelligence whose results rely on data algorithms and computation power. Thus, the core of artificial intelligence and the core of blockchain are both a set of algorithms. Of course they are different. Blockchain is encryption algorithm while artificial intelligence is deep learning, natural language algorithm. So the rules of the digital world are driven by algorithms.
What rules govern economic activity in the digital world without companies?
It has network effects. The value of a network increases with the number of nodes instead of an arithmetic increase, which means it grows exponentially. When a phone network has only one phone, the entire network is worth nothing though it invests $50 billion. When two phones join the network, at least two pairs of communication can be completed. A can call B, and B can call A. But if four phones join the network, will it only add four pairs? No, 4 times 4 is 16. It is16 pairs, so the network effect is exponential growth, not just arithmetic growth of simple addition. Finally, in the last five years, the market value of a lot of Internet startups has gone from zero to $10 billion in one year.
In this new world, everything is redefined by “data”. Distributed bookkeeping is to provide a set of bookkeeping methods and account system for these new economy and new rules, which can help the new economy operate better, more efficiently and at lower cost. Bookkeeping method is a whole set of method system, which should be implemented, so the account is the foundation of bookkeeping method. In terms of distributed ledgers, the account is completely new.
The Advantages of distributed ledger over the existing ledger system
First of all, blockchain accounts are very different from the existing bank account system. It no longer needs to provide personal information at the bank counter and experiences the bank’s information review when opens an account. Opening an account on a blockchain does not require anyone’s permission except a pair of public or private keys generated by an asymmetric encryption algorithm.
Secondly, the encryption account system is actually a computer program, a bunch of code, which can be programmed to make it intelligent and to do a lot of things with smart contracts.
Thirdly, this account has been incorporated, and the only proof that you own the cryptocurrency is the private key. There is no third-party intermediary to help confirm the right of digital currency, that is, our property right.
Fourthly, an account opener is an unspecified object. In the encryption account system, not only individuals and institutions but also the trillions of sensors and other devices on the Internet can also open their own accounts in the future, which is a huge difference from bank accounts. More accounts and transactions will be completed among machines rather than among people. For example, edge computing on the Internet of things develops very fast, requiring tens of billions of machines to calculate locally. It is impossible for them to transfer 100 billion data every minute or every second to the centralized data center and then process the data to send the results back to the Internet of things devices. Another example is the driverless car. If the driverless car sends all the images back to a centralized server and sends instructions to the driver when driving on the road, it will cause a lot of traffic accidents. So, there’s a lot of transaction going on between machines. Accounts on the blockchain are also set up with machines, without permission.
But there is a problem, if you do not need a permission to open an account, then how to evaluate a person and his credit, how to decide what kind of financial services to provide him?
Blockchain has another set of methods to ensure that even if a bad person opens a blockchain account, it cannot expand the scope of evil on the blockchain. There is a set of mathematical algorithm on the blockchain, which ensures that a bad person has no way to do evil or that the cost and benefit of doing evil are not proportional to each other, so that he cannot or does not want to do evil. This is a new set of governance rules in the digital world.
Fifthly, it is a decentralized bookkeeping method. The existing system has a bookkeeping confirmer, but blockchain does not. Blockchain is a multi-party bookkeeping. The parties jointly maintain a ledger, so that the information is completely transparent which allows us to use algorithmic game theory to achieve optimal results. If two people play against each other in an environment where information is not transparent, the worst outcome is often the prisoner’s dilemma. When two prisoners are in two cells, the result is that they both choose to confess due to information asymmetry. On the contrary, if their information is symmetrical, for example, they are in a same cell, they may be released.
Sixthly, why does a set of mathematical rules replace a lot of things on the blockchain? Because it’s information is completely equivalent. In the case of equivalence, everyone will make the best choice, so a set of mathematical rules can be used to let everyone play games on the blockchain. We believe that they will choose a good outcome rather than, as in the prisoner’s dilemma, a poor outcome with asymmetric information.
Seventhly, on the blockchain, multiple transactions can be kept in one account which creates more dimensions, such as the information flow, logistics, and social relations besides the capital flow. You can also match social network information to the accounts. This allows a different approach to implement risk management.
In China, many Internet companies use the data on the Internet to issue credit loans in the form of “310” with an innovative risk management model. The bad debt rate is only 1‰ and 2‰. What is 310? It means 3-minute application, 1-second decision and 0 human intervention. This is digital economy. It takes only 5 seconds to assess that you can borrow as much as 200,000RMB. The money will be transferred to your account in few seconds if you want. This is what blockchain is all about. It requires responses in seconds instead of going through procedures that takes two weeks. What I want is to get the loan within 10 seconds. Now the Internet is able to do that because it has additional identity data, and it can assess your identity data in up to seven dimensions or 17 dimensions, so it does better in credit rating than banks.
Eighthly, the account system of blockchain is the one that truly realizes the principle of penetration. Banks want to be tranparent, but who can penetrate like a blockchain account? The most original data, the most original data, and the most original information can be mastered with non-tampering, permanent preservation and traceability. Accounting relies on consensus algorithms, in which transaction clearing and settlement are done simultaneously so the time unit of account on the blockchain is seconds, not days, not months. The current system of accounting is based on the day as the unit. But in the distributed ledger, the unit is second, so we can finish 7 times 24 hours of trading.
The relationship between blockchain and digital currency
In accounts based on distributed ledgers, the unit of account used is digital currency rather than anything else.
At present, many institutions are trying to use the alliance blockchains to make application attempts on trade and finance. But even in the environment with multi-party alliance blockchains participation, the use of settlement currency is bound to be more efficient, cheaper, more intelligent and automated than legal currency. Of course, it doesn’t use Bitcoin, and its market value is stable. It has some of the characteristics of digital currency, such as being programmable and being able to become a smart contract. Only by programming the digital currency can a large number of clearing and settlement personnel be saved, so that settlement and transaction confirmation can be synchronized. Without coinbase, there would be no improvement of magnitude.
The biggest characteristic of digital currency is that it can be programmed. It is a computer program and a piece of code. Because it can be programmed, it is an intelligent currency. Because it is intelligent, settlement confirmation and settlement transaction are completed at the same time. Everything from programmable money can evolve into programmable finance, and programmable finance can become programmable economy. This prospect is the most valuable thing blockchain brings to us, otherwise it is no different from other advances in computer technology.
Characteristics of digital currency issuance
Firstly, it is a kind of private money. For instance, QQ coin can only be exchanged with legal tender. QQ coins can only be used in Tencent’s applications. It cannot be used beyond Tencent. QQ coins cannot be used to buy things in shopping malls.
Secondly, it is disintermediation publishing. In the process of issuing and circulating of digital currency, the link of money creation is cancelled. The central bank issues the base money and banks and other financial institutions create money, turning one base money into three or five.
Thirdly, based on the issuance of blockchain, there are no silly banknotes, counterfeit banknotes and mutilated banknotes.
Fourthly, transactions are frictionless, efficient and cost virtually zero. It must use this currency to match the business model of the digital economy whose marginal cost and transaction cost is zero. If the general currency flow is in other ways, there is intermediary, the process of money creation, friction and cost, which is not enough to support zero marginal cost, zero transaction cost of the digital economy model.
Fifthly, it is intelligent, automatic and suitable for the digital scene. Distributed ledgers, cryptographic account systems, and digital currencies are bringing about such a new world!