Today's topic is a slight detour from our usual path. A thought came up when I was reading the book "Good Strategy / Bad Strategy" by Richard.P.Rumelt (a highly recommended book to identify fluff from real strategy). The gist of the chapter was - There is power when we gain insights into new sources of strengths & weaknesses. To gain insights into new sources of strengths & weaknesses, we need to think afresh or anew without any noise from our experience which is thinking from First Principles.

What is First Principles Thinking?

First Principles Thinking

Before we define First Principles Thinking, let us take the example of Lego toys.

Lego toys come in blocks or bricks that need to be assembled to create something. What we can create from these blocks is limited only by our imagination. We can build a tractor & then take it apart & build a rocket & so on.

This is thinking from First Principles. The idea is to break down complicated problems into their basic elements & then reassemble them from the ground up (Source: here)

So what was it in that book that made me link Strategy to First Principles thinking & the Blockchain Trilemma - three unrelated topics?

The author gave an example of incumbent KMart being overthrown by upstart Walmart. This was the late 80s or early 90s. (Remember cassette tapes??)

Image by Mikes-Photography from Pixabay

Walmart vs. Kmart

KMart was an American retail company that owned a chain of Big Box Department stores. Their profitability & sales peaked in 1992 & have since declined due to competition with Walmart, Target etc (Source: here)

At the time, KMart was the leader in its industry like Goliath and Walmart was the upstart like David. What was the slingshot that brought down Kmart? Let us explore the way KMart functioned.

At KMart, every decision on procurement & supply chain was decentralized at each store. Thus, the store manager of each location decided on the purchase and inventory management based on their requirements.

Then came the technology of RFID scanners where inventory could be tracked in real-time which resulted in the efficient management of inventory, procurement etc. Both Kmart & Walmart installed barcode scanners at the cash counters but Walmart went further & developed its satellite-based information systems which integrated the inventory management end to end & used the data to streamline processes & negotiate with suppliers. This implementation had to be centralized to ensure a smooth rollout across multiple locations all over the country which enabled them to scale more efficiently & implement what we now call Supply Chain Management.

KMart's decentralized setup was more of a hindrance. If they had to compete, Kmart had to make substantial investments into centralized systems which was against their corporate culture of decentralization where each store manager had the authority to manage their stores & vendors.

KMart's decentralized setup is similar to the foundational concept of Blockchain which is the decentralization of the core functionalities without a central entity having any authority on any component of the Blockchain. So, is 100% decentralization a perfect solution? Are there any trade-offs involved?

What has all this to do with Blockchain Trilemma?

Blockchain Trilemma

Let us see now. But before that, let us understand what is a Trilemma.

As per Wikipedia,

A Trilemma is a difficult choice of three options, each of which is (or appears) unacceptable or unfavorable. There are two logically equivalent ways in which to express a trilemma;

a. It can be expressed as a choice among three unfavorable options, one of which must be chosen, or

b. as a choice among three favorable options, only two of which are possible at the same time.

The term Blockchain Trilemma was coined by Ethereum co-founder Vitalik Buterin.

When setting up a Blockchain, there are three key parameters to consider :

a. Decentralization - How much decentralization is required for a business case? Should the chain be

1. Fully decentralized like Public Blockchains which are permissionless & all nodes have equal rights.

2. Partially Decentralized like Consortium Blockchain where the chain is controlled by a few partner entities?

3. Centralized like Private Blockchains where one entity maintains control over the Blockchain?

b. Security - The more nodes there are in a Blockchain, the more secure the network is. A hacker has to take over 51% of the network to successfully hack the chain. This implies a lesser number of nodes make the Blockchain more vulnerable to hacks.

c. Scalability - First, what is scalability? In any business, scalability means growing while maintaining the same level of quality or service. In a Blockchain, it means growing the chain while maintaining the same transaction speeds & output.

To scale efficiently, a company needs to invest in resources & technology to maintain the same level of quality or service at a higher number of transactions or customers.

Considering the above diagrammatically

Blockchain Trilemma means that If we select one or more of the above options, there is a trade-off involved. Assume we decentralize & scale more, meaning more nodes to create or validate transactions & miners to maintain the network. This should be good, right? More nodes, more security. But unfortunately, there's a catch. More transactions mean more data. More data means more storage space required resulting in clogging up of existing space & more time required to process transactions. Same as real-life cases of infrastructure like roads not keeping up with the number of cars resulting in traffic jams.

So, is the solution not to scale? If we don't scale, the network will not be secure (remember, more nodes - more security).

For mass adoption of Blockchain, scalability is critical & Blockchain being inherently decentralized is conceptually "ready" for scaling. But more scaling results in slow transaction speeds. So, how do we resolve this trilemma of balancing between decentralization, scaling & security?

Maybe this calls for a solution from First Principles Thinking. Let us explore these in the coming weeks.