5 Hurdles Blockchain Faces to Revolutionize the Banks

We still have some way to go before banks turn blockchain, but is it a long way or a short one?
We still have some way to go before banks turn blockchain, but is it a long way or a short one?

Blockchain is termed as the next step in the digital revolution, a technology that will change every industry from music to waste. When it comes to money, it goes well beyond bitcoin. Academics have claimed it will “do to the banks what the internet did to media”.

There are several versions of public blockchains in existence, but most of them share a basic premise: they provide a secure, decentralized infrastructure to maintain a “single version of the truth”, recording all changes made on the blockchain database since its formation.

Whether we buy our groceries online, pay for a service through our mobile phone, or transfer funds abroad, transactions will almost immediately be recorded on the distributed ledger of the blockchain, instead of waiting a couple of days for it to register in our account as banks contact each other on a system invented in the 1970s.

A lot of banks and fintech started experimenting with blockchain in 2015 – trying to capitalize on the speed and transparency it provides. But four years later, the idea that blockchain will remove banks as intermediaries in our payments system still seems a long way off. That’s because there are five basic challenges that technology has to overcome if it is to be accepted as part of the financial system.

1. Governance

Blockchain’s strength has no central authority, but this is also a weakness. Who makes the decisions about how the technology works or when it needs updating?

If Microsoft Windows needs an update, Microsoft will decide on that and send out an update. But with no central decision-maker, decisions about updates in the world of blockchain become slow and dysfunctional.

Public blockchains function similar to communities. There is no systematic way to decide on updates or improvements. Instead, they happen through massive debates between ecosystem participants, with groups arguing over issues like the length of a block, the number of transactions it should hold, and how fast they should be chained. Often there is no solution to these debates, with no way to organize these communities and make decisions.

Sometimes this can result in a split. That’s what happened in 2016 when 3.6m ether (amounting to roughly US$60m at the time) was stolen on the Ethereum cryptocurrency network.

Blockchains haven’t figured out how to effectively govern yet. Often, simple majority voting mechanisms are used to make decisions, which means issues are vulnerable to lobbyists or particularly active contributors seizing control.

2. Scalability

Despite blockchain’s popularity, it is still on a very small scale compared to everyday electronic payments. At the moment, bitcoin’s blockchain does 2,000 transactions every ten minutes, whereas Visa handles more than 65,000 transaction messages every second, and SWIFT – the global messaging system used by banks and financial institutions to transfer payments – deals with approximately 24m messages a day.

The “block size debate” over how many transactions each block of a blockchain should handle has raged since the early days of bitcoin in 2009. This must be resolved for blockchain platforms to grow big enough to become part of the world’s financial plumbing.

3. Standards

Various blockchains organize information in a plethora of ways. This means sending information from one to another is not always easy.

There is no agreed universal layout of the transaction data structure. when paying through banks, a block will hold the person or company’s name, account information, payment, location address, and any other relevant factors. But cryptocurrencies all do this differently, so it would be difficult to move from one currency to another. They need to create standards for the information they contain and how it is systematically laid out.

Who should create these standards, though? There needs to be a body taking the lead on this and a consensus must come to the fore, like the Internet Engineering Task Force (IETF) has done for the internet.

4. Liability

There is no liability for the platforms when things go wrong at the moment. For instance, in 2017, Canadian digital currency exchange QuadrigaCX announced that a computer error had led to losses of ether worth US$14m.

The ether was trapped in the Ethereum system, but the Ethereum community decided not to take any action in recovering it and so QuadrigaCX had to swallow the loss so no client balances were affected.

Surely, liability will need to be cleared up before the public can trust blockchains with their money. For this, we need more regulation in the space of crypto and blockchain in general.

5. Transparency and identity

Blockchain payments mean all users can see all the transactions, making them easy to audit and trace. Users are pseudo-anonymous, in that they are not obliged to identify themselves in any way, but they can still be traced through their alphanumeric address and use of tokens on the network. This transparency is part of the blockchain’s strength. It means other users can see the number of bitcoins going from one address to another, but no name is linked to that address.

The current system, SWIFT, is a private network infrastructure. It is considered secure and resilient, allowing access only to users who are fully identified and verified as legal entities in the finance sector. Eventually, blockchain’s lack of an identification framework will be problematic for many users and investors as it is a fundamental premise on which the financial system is built. Until these issues are addressed, it is hard to see public (and to some extent private) blockchains becoming the new foundation of our financial system.

 

You can learn about the reasons for Bitcoin’s success