WEEKLY - blockchain blurs definitions
and Happy Holidays!
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🎄🎄🎄 HAPPY HOLIDAYS!!!! 🎄🎄🎄
In this newsletter:
Shifting concepts: What is a transaction?
The most wholesomely hilarious Christmas video
Some of the topics discussed this week:
An EU digital euro twist
Central banks, uncertainty and the dollar trap
The impact on crypto
Credibility on the line
The data that matters
What is a transaction?
An unusual mainstream explainer
Public markets
Market jitters
The trigger and the overreaction
Progmat, tokenization and Japan’s blockchain strategy
Newsletter stuff
Shifting concepts: What is a transaction?
One of the aspects I find most exciting about crypto assets and blockchain technology is how it forces us to rethink what we thought we knew. It teaches us about the weak hold of language, about how form doesn’t always fit function and how, when you poke deeper, things generally don’t become clearer, they become more confusing. Personally, I enjoy that, but most hate it, which is why the easy thing to do is to assume definitions are solid and never change.
Take “money”, for instance. I used to work in traditional finance, I thought I understood it, but it turns out I was just conflating money with numbers that I moved around. It wasn’t until I started to research Bitcoin that I realized I didn’t understand money at all, and I am certain most in traditional finance today still don’t.
It’s not that the crypto ecosystem is any better at questioning the terminology we use. We accept that the definition of “money” is being prodded and stretched, but we happily use “blockchain” even for systems that have neither blocks nor chains. We say “stablecoin” even though we know fiat currencies aren’t stable. And we assume everyone understands what we mean by “transaction”.
This last point may seem like a stretch, because we need a term to cover the exchange of one asset for another. But when you poke at this concept, you’ll see how vague a word it is. And in finance, details matter.
(image via Bloomberg)
Definitions
Type “transaction” into Google’s definitions box and you’ll get: “an instance of buying or selling something”. Simple enough. The “something” doesn’t have to be physical or even digital, it could be a commitment or an experience. But is a donation a transaction? If you’re giving a handful of coins to a homeless person on the street, that doesn’t feel like one. But if you donate to a homeless shelter via PayPal, that does, largely because you’ll get a message from PayPal saying something like “transaction successful”. PayPal is indifferent to your intent; it processes the transaction.
On a blockchain, it’s both similar and more complex. If I want to donate some BTC to a shelter, that is registered as a transaction on the Bitcoin blockchain. Some tax authorities would treat it as a sale and I’d have to declare capital gains. This conceptually makes it two transactions, a donation of funds and a sale of an asset, while to an observer, it’s only one.
You’re starting to see how complex the term transaction is when you dig deeper, both conceptually and technically? And we’re just getting started.
Financial transactions
A key part of any financial asset transaction is the settlement – a trade is not considered final until payment has been received and ownership of the asset has been transferred.
In traditional finance, that involves several steps on different ledgers.
On a blockchain, it involves fewer steps, with smart contracts potentially compressing them further. You’d think this would make settlement simpler, and to some extent, it does. But to show why it can also be more complex, as an example let’s just look at a transfer of BTC.
I won’t go into a detailed explanation on how Bitcoin works, but in brief: network validators (“miners”) compete to process blocks of transactions by trial-and-error, with computers searching for a missing variable that meets the protocol’s specification. When a computer finds the variable, that block gets attached to the chain. Only, maybe another block was attached to the chain at the same time. We won’t know which one becomes the consensus block until another is successfully processed and attached to one of the two options.
And even then, it’s not a done deal – maybe the next two blocks after that attach to the temporarily shorter chain, making it the longest. Network latency means that not all processors see the same chain at the same instant, and this can lead to blocks being added to the chain only to later be kicked off in favour of a luckier usurper. These “forks” rarely last more than a few minutes, as the network operates on the assumption that the longest chain is the valid one. But it underscores that Bitcoin settlement is probabilistic. Its finality depends on how many blocks have come after, how deep in the chain the transaction is, and how hard it would be to alter it.
A market transaction can’t be probabilistic, though.
The typical solution to this is to insert centralized commitments, such as assumption of liability if anything goes wrong, or the condition that a Bitcoin transaction is considered “final” three blocks in.
On many networks, this is trivial as blocks are processed quickly and consensus on some can be almost instant. But the example serves to highlight a key difference to how blockchains are changing basic financial concepts.
Increasing complexity
As if all that wasn’t complicated enough, what traditional finance folks understand to be one transaction, blockchains register as several. Centralized entities can decide what constitutes a transaction, with subordinate steps making the whole thing possible. Onchain, each step is a transaction (I’m simplifying here, there are different types of steps but the general point holds).
Let’s say I want to use a decentralized exchange (DEX) to swap 100 USDT stablecoins, held on Ethereum, for the same amount of USDC. I send my USDT to the DEX (one onchain user-generated transaction), the smart contract swaps it for USDC, and I claim the USDC from the smart contract (another onchain user-generated transaction). And in between, there are transaction fees paid to the validators, and probably some other steps I’m overlooking. What’s more, this process varies between blockchains.
The swap itself is technically not considered a transaction, as it would be in traditional finance – rather it is a contract execution. The end result is of course what matters for blockchain users, but when building services that fit into regulatory frameworks, the distinction could become relevant.
Let’s ratchet up the complexity some more. Different blockchains treat transactions differently, with different data structures. Bitcoin’s transaction format, for instance, is different from that of Sui or Avalanche or Celestia. And then there’s the wide range of permissioned blockchains, which can be adapted to suit regulators but which are still based on a new understanding of “transaction”.
Each wants to be able to improve on traditional finance functionality and efficiency; but fitting into traditional definitions will not be as simple as many seem to think, especially in a multi-chain universe. We should spare a thought for market supervisors trying to fit this into familiar frameworks.
It’s doable, of course. But there are so many decisions along the way, each with a range of paths that could impact how the traditional and distributed worlds interact.
All of this matters a lot for the eventual adoption of blockchains, tokenized assets and security tokens by traditional participants, because regulators need to know what a transaction is. Reporting is a big part of market oversight – when it comes to blockchains, what needs to be reported? There are clear advantages to regulators running network nodes in order to have insight into real-time market movements – but what information from those nodes is relevant, and how should it be formatted?
Like I said earlier, in finance, details matter. And in a global system as embedded in society as are financial markets, changing the way data is understood is doing much more than just throwing a spanner in the cogs. It’s asking groups that are conservative by nature to embrace radical change when they tend to see the current system as “good enough”.
Of course, innovation will win, and blockchains do present an obvious opportunity for better market infrastructure and flows. But it’s worth appreciating just how mammoth the adaptation task will be. There has already been significant progress on this front over the years, with sandboxes and trials and a deeper understanding of the technology. And I do believe that 10-15 years from now, markets will be trading more blockchain-based tokens than traditional securities. In the meantime, we get to watch the pieces fall into place.
HAVE A GREAT WEEKEND!
(in this section, I share stuff that has NOTHING to do with macro or crypto, ‘cos it’s the weekend and life is interesting)
Keeping it short and sweet this week: this has to be one of my favourite Christmas videos, obviously in part because of the chorus, but mainly because it’s wholesome and hilarious.
🎄🎄🎄 HAPPY HOLIDAYS!! 🎄🎄🎄
DISCLAIMER: I never give trading ideas, and NOTHING I say is investment advice! I hold some BTC, ETH and a tiny amount of some smaller tokens, but they’re all long-term holdings – I don’t trade.