The Blockchain: Hype Versus Reality
No discussion about the future of business is complete without mentioning blockchain.
The blockchain was supposed to change everything—save businesses money, increase transparency, and enhance security. The future of business is decentralized.
It may very well still be—yet, despite years of research and a ton of resources poured into blockchain development by both startups and incumbent companies, little has come to fruition to change established practices.
Instead, the blockchain has mostly been changing itself, with various permutations of the technology being invented to fit into existing paradigms.
Fundamentally, the blockchain—which was introduced by the bitcoin digital currency in 2008—is a type of database that’s validated by a user community instead of controlled by a centralized organization, such as a bank or governmental authority. That’s the basic premise, but it gets exponentially more complicated from there.
Each block stores transactional data, which is linked (or chained) together with a hash function (an encryption procedure). As new records are created, the decentralized user community—connected by the internet—confirms and verifies the records as accurate.
The entire blockchain is saved on the computers used by the community, so there’s no individual that can control, erase, or tamper with the underlying data. In theory, this creates a permissionless and transparent public domain of data that could be more trustworthy than data unilaterally controlled by a person or organization.
It’s easy to envision practical applications of this technology. It could facilitate peer-to-peer transactions of value without the need for central authorities, such as banks.
Blockchain-based business transactions eliminate time spent by counterparties to verify the accuracy and completeness of underlying terms. Health care providers can use the blockchain to securely transmit patient records. Voting systems based on the blockchain can reduce risk of fraud or hacks.
Blockchain Arms Race
All of this promise has led to immense investment into this space.
China has been a big spender in financing blockchain research. A May 4 statement by China’s State Council—its official cabinet—said, “We will quickly develop financial technology and accelerate the research and application of blockchain and big data technologies.”
In April, the eastern city of Hangzhou launched a 10 billion yuan ($1.6 billion) investment fund called Xiong An Global Blockchain Innovation Fund, specifically to invest in startups researching blockchain technology. China’s enthusiasm for blockchain technology is not surprising, given its wide adoption of fintech and cashless transactions. Mobile and peer-to-peer payment networks, such as WeChat and Alipay, are widely used there.
The global financial services community is also pouring millions of dollars into developing blockchain technologies.
Blythe Masters, the former JPMorgan Chase & Co. banker credited with inventing the credit default swap in the 1990s, currently leads Digital Asset Holdings, a New York-based fintech firm that researches blockchain technologies for banking and financial applications.
Bank of America Corp. has applied for or received at least 43 blockchain-related patents as of January 2018, according to blockchain industry site CCN.com. Several major banks, including Japan’s Mitsubishi UFJ Financial Group Inc. and the UK’s Standard Chartered, are testing blockchain-based cross-border payments in Asia using technology developed by Ripple.
That’s all just the tip of the iceberg. In a recent survey conducted by consultancy Accenture, 60 percent of financial executives believe that blockchain and smart contracts will be “critical to their organizations over the next three years.” At the 2018 Consensus Conference held in May, FedEx Corp.’s CEO Frederick Smith stated that blockchain has the potential to “revolutionize trade” across countries.
In many ways, the financial sector’s blockchain arms race feels like a fait accompli. Companies buying into blockchain behave similarly to consumers who bought cryptocurrencies earlier this year due to “FOMO,” or fear of missing out.
But there are critical roadblocks, some of which are fundamental to the existing state of competition, which must be cleared before blockchain adoption can reach its potential.
A big technical hurdle is efficiency and speed. By its very nature, a decentralized database requiring a majority of constituents to agree and validate each transaction (called “proof of work” in blockchain jargon) is slower than a centralized one.
Earlier this year, some bitcoin transactions took more than two days to settle. While improvements to the underlying network have increased the speed considerably since, it underscores the inherent speed challenges in a decentralized environment.
Consultancy Opimas observed that this concern around scalability has led to some major industry players—including Digital Asset Holdings and R3—to focus on a smaller shared ledger instead of a distributed one.
“In this infrastructure, market participants’ nodes only keep a record of the transactions to which they are a counterparty, and that they upload from a central ledger that keeps a record of all transactions,” Opimas wrote in its report, according to the Financial Times.
“This is quite an evolution from the initial blockchain model, as the infrastructure becomes a semi-distributed environment in which a partial ledger co-exists with a central ledger.”
This model, which isn’t very decentralized or permissionless, does not differ greatly from how data is stored today.
Another major hurdle is inherent to the nature of business and competition, and it has existed for thousands of years: Different institutions simply cannot agree. This is a main reason for why the European Union has become dysfunctional and the euro currency is so maligned.
The blockchain, by its very definition, is not flexible or dynamic enough to accommodate different protocols. Changes to underlying code that change its behavior make it incompatible with itself and create a whole new blockchain, known as a fork.
The original bitcoin has spawned several versions—Bitcoin Cash, Bitcoin Gold, and Bitcoin Private, to name the major ones—because its miner and developer-community could not agree on a common path forward.
In a research paper by the SWIFT Institute, a group of researchers pointed out that while blockchain is a good idea for the financial services industry, the ability to coordinate and agree presents the biggest challenge.
“Opportunities for sharing data through distributed databases have been around for years,” the researchers wrote, “but there is a danger of building unrealistic expectations of the extent to which this technology will, on its own, address the underlying need for coordination of business processes within and between firms.
“We do think that full senior management buy-in to mutual distributed ledgers will only happen after taking account of the implications for their competitive positioning and may not happen at all without addressing the incentives and cultures that drive decision making in major financial institutions.”
A more recent development in Europe presented another difficulty for blockchain development. The EU’s General Data Protection Regulation (GDPR) requires companies storing user data to erase such information at the request of the user. This legislation has already created some angst among internet and technology companies.
There’s intrinsic tension between GDPR and the blockchain: Data on the blockchain cannot be erased due to its decentralized and tamper-proof nature. GDPR and other similar legislation require that user data should be erased or forgotten if requested, which conflicts with how the blockchain works. The conflict has led some blockchain proponents to advocate that the EU grant blockchain databases an exemption from GDPR rules.
“I think it’s safe to say that currently, most blockchains are incompatible with the GDPR, especially permissionless blockchains,” University of Oxford law lecturer Michele Finck told technology website The Verge recently. “There are so many points of tension … way beyond the right [for personal data] to be forgotten.”
It could take years for blockchain to fully manifest, and, by then, the regulatory and business environment could change and new blockchain technologies could emerge.
For now, companies cannot assume that blockchain systems will replace existing networks and become their cost-saving panacea. It might one day, but at what cost?