Separating the bitcoin hype from the blockchain substance

Blockchain promises to be the next Internet-sized disrupter. But not yet. Check back in about a decade.

The hype machine is running full bore promoting the bitcoin digital currency, as well as the blockchain secure transaction directory that underlies it, as technologies that will take the world by storm in 2016.

Don’t believe it.

There’s a pretty good chance blockchain will disrupt financial and administrative services similar to the way the Internet continues to disrupt the publishing, retail, and other industries. Just as it took the Internet about a decade to travel the path from geeks only to mainstream, blockchain’s impact won’t hit home until sometime around 2026, according to most prognosticators.

For example, Chris Skinner writes in a December 1, 2015, post on the Financial Services Club blog about the Waterfall Effect: Technologies cascade from idea to implementation to acceptance to mainstream in a process that takes about ten years to complete. Because it does away with financial intermediaries, blockchain will fundamentally transform banking, securities, and other financial services. However, adoption will require integrating blockchain with the existing financial networks to some degree during the transition.

What the heck is a ‘self-validating transaction directory’?

In any financial transaction, there’s a seller, a buyer, and a third party who verifies that the seller has the legal right to sell the item, and that the buyer’s payment for the item is valid. The third party is usually a government that issues and validates documents, and that guarantees the value of the currency used in the transaction; or a bank or other financial entity that confirms the payer’s funds are indeed available to the seller.

Blockchain removes the third-party requirement from the process because it confirms that the seller owns the item being sold, and the buyer’s payment for the item is valid. It does this via a transaction directory that contains a history of the creation and ownership of an asset. Two great primers on blockchain are an October 3, 2015, article by Tech Crunch’s Florian Graillot, and a January 13, 2015, article by Mohit Kaushal and Sheel Tyle on Brookings’ TechTank.

All the information about an asset is stored in a block. To validate a transaction, several nodes comprising the blockchain network have to agree, after applying their “sophisticated algorithms” to validate it. Blockchain relies on cryptography to ensure the anonymity of all parties to a transaction. In that way, it works like cash. It also relies on a network of computers around the globe that have no central controller. Here’s an excerpt by Kaushal and Tyle:

“The elegance of the Blockchain is that it obviates the need for a central authority to verify trust and the transfer of value. It transfers power and control from large entities to the many, enabling safe, fast, cheaper transactions despite the fact that we may not know the entities we are dealing with.”

Among the casualties of widespread adoption of blockchain are “auditors, legal services, payment processors, [and] brokerages,” according to the authors.

Why bitcoin may never be mainstream

While blockchain’s long-term outlook appears bright, no less a personage than former Federal Reserve Chairman Ben Bernanke believes bitcoin has “serious problems,” as reported by Stan Higgins in a November 19, 2015, article on CoinDesk. Yet the digital currency’s value has rebounded after recent declines, although at least one analyst (Bloomberg) credits much of the recent increase in bitcoin’s value to the overall strength of currency markets.

In an interview with Quartz, Bernanke stated that bitcoin’s price is “highly volatile,” and he doesn’t believe the currency has established itself as a “widely accepted transaction medium.” Bernanke also cited bitcoin’s reputation as the source of funding for myriad illegalities, in the real world and in the digital realm. However, what might be bitcoin’s Achilles heel is its inability to process more than 7 transactions per second (tps).

As Tom Simonite explains in an August 28, 2015, article on MIT Tech Review, Gavin Andresen, the person who has been “chief caretaker” of bitcoin since 2010, believes transaction delays will cause the bitcoin network to malfunction beginning in 2016. Andresen has proposed increasing the size of blocks, which would “fork” the technology: some bitcoin “miners” (the people who run the algorithms that do the validating) will use the old block size, and some will use the new larger size.

Positive Money’s Ben Dyson writes in an April 5, 2014, article that bitcoin has three fatal design flaws: 1) The limited number of bitcoins causes people to treat them as a speculative investment rather than a spendable currency (they hold onto them); 2) It rewards early adopters – today’s tech-savvy miners – at the expense of people who arrive later; and 3) Despite not being centrally regulated, bitcoins are less secure than national currencies, as shown by the theft of the equivalent of $460 million in bitcoins when the Mt. Gox exchange was hacked in 2014. (Wired’s Robert McMillan reports on the theft’s aftermath in a March 3, 2014, article.) 

Promising crypto-currency alternatives to bitcoin

Another of Dyson’s criticisms of bitcoin is that it was developed as a prototype that was never intended for widespread use. Several groups are developing digital currencies designed to address bitcoin’s shortcomings. A recent arrival that has some big-name backing is called eCurrency, which PaymentsSource’s Penny Crosman dubs “the anti-bitcoin” in a December 15, 2015, article. (Yes, the author’s first name really is “Penny.”)

eCurrency, which has eBay founder Pierre Omidyar as a backer, is noted for allowing central banks to issue digital currency based on “the full faith and credit of the government.” However, it retains bitcoin’s cash-like anonymity and universal acceptance. Jonathan Dharmapalan, founder and CEO of eCurrency Mint, states that digital currency has to be issued by a central bank to prevent replication and to keep its value stable. The currency also has to have a legal identity, and it has to work with existing currency systems.

The company intends to focus on emerging countries with little banking infrastructure initially, similar to the M-Pesa mobile money system that has taken root in Kenya and elsewhere in East Africa. However, eCurrency Mint is also working with the U.S. Treasury and central banks in 30 other countries, according to Crosman.

No matter how you look at it, money is changing (ahem). Young people in particular are demanding that financial services adapt to the way they transact business, which increasingly is by digital means. It won’t happen overnight, or even next year. But as sure as the Internet converted writing from an occupation to an avocation, the coins of the realms are going virtual. DIY financial services are just a matter of time.

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