Blockchain Revolution

DR. FAUST’S BLOCKCHAIN BARGAIN
Banks and transparency rarely go hand in hand. Most financial actors gain
competitive advantage from information asymmetries and greater know-how than
their counterparties. However, the bitcoin blockchain as constructed is a radically
transparent system. For banks, this means opening the kimono, so to speak. So how
do we reconcile an open platform with the closed-door policy of banks?
Austin Hill called it Wall Street’s “Faustian bargain,” an onerous trade-off.
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“People love the idea of not having to wait three days to settle transactions but having
them cleared within minutes and knowing that they’re final and that they’re true,” said
Hill. “The counterpart to that is all transactions on the [bitcoin] blockchain are
completely public. That terrifies a number of people on Wall Street.” The solution?
Confidential transactions on so-called permissioned blockchains, also known as
private blockchains. Whereas the bitcoin blockchain is entirely open and
permissionless—that is, anyone can access it and interact with it—permissioned
blockchains require users to have certain credentials, giving them a license to operate
on that particular blockchain. Hill has developed the technology whereby only a few
stakeholders see the various components of a transaction and can ensure its integrity.
At first blush, private and permissioned blockchains would appear to have a few
clear advantages. For one, its members can easily change the rules of the blockchain if
they so desire. Costs can be kept down as transactions need only validation from the
members themselves, removing the need for anonymous miners who use lots of
electricity. Also, because all parties are trusted, a 51 percent attack is unlikely. Nodes
can be trusted to be well connected, as in most use cases they are large financial
institutions. Furthermore, they are easier for regulators to monitor. However, these
advantages also create weaknesses. The easier it is to change the rules, the more likely
a member is to flout them. Private blockchains also prevent the network effects that
enable a technology to scale rapidly. Intentionally limiting certain freedoms by
creating new rules can inhibit neutrality. Finally, with no open value innovation, the
technology is more likely to stagnate and become vulnerable.
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This is not to say
private blockchains won’t flourish, but financial services stakeholders must still take
these concerns seriously.

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Ripple Labs, which has gained traction within banking circles, is developing other
clever ways to relieve Faust. “Ripple Labs is aimed at wholesale banking, and we use
a consensus method, rather than a proof-of-work system,” said CEO Chris Larsen,
meaning no miners and no anonymous nodes are validating transactions.
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The
company Chain has its own strategy. With $30 million in funding from Visa,
NASDAQ, Citi, Capital One, Fiserv, and Orange, Chain plans on building enterprise-
focused blockchain solutions, targeting the financial services industry first, where it
already has a deal with NASDAQ. “All assets in the future will be digital bearer
instruments running on multiple blockchains,” argued Chain CEO Adam Ludwin. But
this won’t be the siloed world Wall Street is accustomed to, “because everyone is
building on the same open specs.”
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Wall Streeters might want to capture this
technology, but they will have to contend with the value innovation it enables,
something they can’t control or predict.
Masters also sees the virtues of permissioned blockchains. For her, only a small
coterie of trading partners, some vendors and other counterparties, and regulators
need have access. Those select few chosen will be granted blockchain credentials. To
Masters, “permissioned ledgers have the advantage of never exposing a regulated
financial institution to the risk of either transacting with an unknown party, an
unacceptable activity from a regulatory point of view, or creating a dependency upon
an unknown service provider such as a transaction processor, also unacceptable from
a regulatory point of view.”
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These permissioned blockchains, or private chains,
appeal to traditional financial institutions wary of bitcoin and everything associated
with it.
While Blythe Masters is the CEO of a start-up, her keen interest represents
broader involvement of traditional financial actors in this sector. This embrace of new
technology reflects a growing concern that tech start-ups can also upend high finance.
For Eric Piscini of Deloitte, whose clients have undergone a great awakening over the
past year, the “sudden interest in tech was not something that anyone was
expecting.”
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The enthusiasm is spreading like a contagion into some of the largest
and oldest financial institutions in the world.
Barclays is one of dozens of financial institutions exploring opportunities in
blockchain technology. According to Derek White, Barclays’s chief design and digital
officer, “technologies like the blockchain are going to reshape our industry.” White is
building an open innovation platform that will allow the bank to engage a wide array
of builders and thinkers in this industry. “We’re keen to be shapers. But we’re also
keen to connect with the shapers of the technologies and the translators of those
technologies,” he said.
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Barclays is putting its money where its mouth is, cutting tens
of thousands of jobs in traditional areas and doubling down on technology, notably by

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launching the Barclays Accelerator. According to White, “three out of the ten
companies in our last cohort were blockchain or bitcoin companies. Blockchain is the
greatest evidence of the world moving from closed systems to open systems and has
huge potential impact on the future of not just financial services but many
industries.”
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Banks talking about open systems—mon Dieu!