Complicated to understand and unruly, blockchains have reached the teenage phase. It would be an understatement to call the technology “cool” but most financial institution’s currently building blockchain architecture haven’t yet figured out how to take advantage of it successfully.
There are proofs of concept, partnerships and pilots. Something (who knows what) will come out of all this interest, but as the industry continues it’s fast paced experimentation, there’s sure to be several more missteps before anything tangible makes an appearance in the public.
But these missteps can be learned from.
Beware of The DAO
Sounds like a scary movie.
What started out as an autonomous online crowdfunding platform, The DAO (digital autonomous organization) running on popular Blockchain platform Ethereum became famous for raising $150m dollars “the VC without humans”. After an initial fanfare and euphoria things took a turn for the worse when –after a vulnerability was exploited in the code–users were stripped of $60 million worth of DAO tokens.
The important thing for financial institutions to glean from the theft is that these startup project’s code needs significant quality assurance to be ready for regulated prime time.
In a Medium post introducing The DAO, Stephan Tual, founder of Slock.it, the company which wrote The DAO’s code, said:
“…the DAO has educated the public in the importance of checking the source code and validating the bytecode of such projects.”
For a community of people that want the world to run on computer code, it seems not many of them actually take the time to inspect the code.
After the attack, Vitalik Buterin, co-founder of Ethereum published a critical update in which he stated:
“Contract authors should take care to…avoid creating contracts that contain more than ~$10m worth of value, with the exception of sub-token contracts and other systems whose value is itself defined by social consensus outside of the Ethereum platform, and which can be easily “hard forked” via community consensus if a bug emerges, at least until the community gains more experience with bug mitigation and/or better tools are developed.”
The highlighted seems a cryptic way of saying users should think about holding large amounts of value in Fiat currencies at regulated financial services institutions where one has recourse in case of hacks and theft. Perhaps Blockchain’s rather than replacing banks; need banks?
Earlier this month, Buterin penned a report published by blockchain tech company, R3CEV on how banks should look at the alternative blockchain; Ethereum. Buterin believes Ethereum will eventually get to the same scale banks and payments providers need, but cautioned financial institutions saying the network is still in its infancy and needs substantial work.
One of the main concerns: Privacy–since blockchains post all data transparently. For financial institutions coming together in blockchain consortiums, this could pose a problem in terms of sharing business sensitive data. It seems Blockchain’s are growing up, but not without some growing pains.
Still, Banks Move Forward
Even with this discretion, banks are preparing for the blockchain revolution. This month, another slew of financial institutions began working together on developing blockchain infrastructure for enterprise use cases.
Ripple added seven new financial institutions to its list of partners. Hyperledger, an open-source “business” blockchain project led by the Linux Foundation also secured seven new members, bringing its total to 44. And another seven financial firms including BNP Paribas Securities Services and Societe Generale began working together to explore how blockchain tech could lower the costs of post-trade settlement services.
Also this month, the Australian Stock Exchange bought a larger stake in Blythe Masters’ blockchain startup, Digital Asset Holdings. Upping its stake in DAH came after investing about $7.1 million in the company after it initially invested $10.5 million in January. The exchange is exploring whether its current system can be upgraded with blockchain technology.
Central banks are also taking note. In the US, Federal Reserve chairwoman, Janet Yellen urged central bankers to explore new financial technologies, expressly blockchain and bitcoin.
The Bank of Canada has been experimenting with a digital fiat currency on a distributed ledger with the Canadian Payments Association and the Royal Bank of Canada. Leaked from the Payments Panorama conference in Calgary, what the institutions are calling CADcoin is relegated to an interbank payments system built by R3, Payments Canada and a slew of Canadian banks.
In the flurry of hype surrounding the Canadian central bank’s work, the senior deputy governor of the Bank of Canada, Carolyn Wilkins, penned a column for CoinDesk saying:
“Other frameworks need to be investigated, and many hurdles need to be cleared, before a [distributed ledger technology] system is ready for prime time. Whether they’re based on DLT or simply interesting twists on existing technologies, financial innovations could solve some old problems.”
Across the pond, The Bank of England launched a fintech accelerator in an effort, according to the website, to create a more resilient financial infrastructure with more effective trade and settlement. One area the Bank of England is especially interested in is distributed ledger technology and how it might work for central banking systems.
But even though these large financial institutions are opening their minds to innovative technologies such as blockchain, the industry is having trouble retaining talent.
This month, Barclays’ vice president of blockchain research and development, Simon Taylor exited the big bank for Chris Skinner’s blockchain strategy and venture capital fund, 11:FS (which operates this media brand). In the past year, Barclays has lost four people to R3CEV, a firm focused on building blockchain architecture for financial institutions. And compliance officers are leaving their cushy jobs with banks to join funded startups. The key question for banks is what is the right use case, talent and partnership model for success? It certainly appears the race to find the answer has started.
Interest and Uncertainty
All this shows a continuing interest in blockchain especially permissioned ledger technology even though no such network has been commercially launched yet.
But even the pride and joy of the blockchain world, Bitcoin has run into some hurdles after an intense debate over increasing the blocksize to allow more transactions to be authenticated within the 10 minute verification window.
Plus in the next week, the bitcoin mining reward will halve, decreasing the reward miners get for verifying blocks from 25 bitcoin to 12.5 bitcoin. Many wonder whether this will lead many mining shops to close because of lost revenue.
Bitcoin is still seen by many regulated financial entities as too risky to touch. That’s likely as a result of community sentiment remaining hostile towards legacy finance.
During a Liberty Entrepreneurs podcast, Roger Ver, the outspoken angel investor in all things bitcoin, said:
“Bitcoin is not only competing with other crypto-currencies, but against the legacy financial system as well.”
Erik Voorhees, an early bitcoin entrepreneur who’s currently the founder and CEO of Shapeshift.io one-upped that critique, saying:
“The whole Bitcoin experiment is pointless if it doesn’t replace the entire financial system.”
Voorhees, who was fined by the Securities and Exchange Commission related to an unregistered stock offering associated with online gambling site, Satoshi Dice advocates for the separation of money and state, calling the current system fraudulent.
While he’s a critic of the system, he continued with an observation all financial institutions would do good to contemplate.
“It takes a lot to pull someone out of their habits and everyone is used to their normal payments systems. So when you are going to them and making the case to ‘use Bitcoin because it’s better’ most of the world isn’t going to care about the ideological reasons for it. They should, but they just won’t. They need to have some sort of emotional experience and get excited about it. If that experience sucks then they are not going to use it,” Voorhees said.
Financial institutions can save a lot of time and money making sure it’s building products and services consumers are actually interested in.
Unlike Bitcoin, though, the legacy industry cannot simply ignore regulation. Key developments in R3CEV, DAH and other market leaders in the DLT space appear to be inspired by Bitcoin but starting to build prototypes that are radically different. Very much like the similarities/differences between a horse and a seahorse–names and a shared ancestor–but are drastically different animals.
Another issue with the cryptocurrency community is that Bitcoin is referred to as magic internet money and blockchains as magic internet chains, which seems like a cute joke but distorts the technical details behind the protocols. This is bad not only for financial institutions currently experimenting with these technologies but also consumers that are already abstracted from many of the systems they use, putting them at a severe disadvantage.
Trying to weed through the complexities, though, a group of about 100 blockchain and Web enthusiasts got together for the World Wide Web Consortium (W3C) Blockchain Workshop on June 29-30 to discuss what blockchain functions might be standardized to promote competition and advance new Web technology.
The open blockchain space continues to garner the majority of the interest from external press and remains a source of constant innovation and growth. With both Bitcoin and Ethereum continuing its rollercoaster momentum, its price and resilience are being tested significantly.
The consortia and startups focused on private blockchains are gaining momentum too but with much less fanfare. It’s clear banks cannot afford to miss the developments happening in this space given the level of development and investment. Collabortation and blockchain architecture has been shown to reduce the costs of transacting and can improve provenance tracking.