What Blocks the Blockchain

by George Peabody on April 14, 2016

in Bitcoin, Blockchain, Financial Regulators, Regulatory Environment

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Given the high rate of press releases and articles on fintech applications of blockchain technology – and the growing number of financial institutions expressing interest in its potential – I’ve been considering this high signal to noise ratio. A few thoughts:

Hype cycle inflection point

We are, hopefully, cresting the top of the blockchain hype cycle. In recent months, a number of bitcoin technology efforts shifted their focus from bitcoin to blockchain technology as the step most likely to gain positive attention, the theory being that blockchain beauty shines brighter when extracted from bitcoin’s murk. So, in 2016, both hype and serious discussion of blockchain technology are plentiful. Sometimes this serious exploration flirts with flights of fancy.

Welcome to the pilot stage

Almost all of the blockchain initiatives today, especially those looking to automate back office functions, are pilot programs—some just requirements documents, others are early iterations of software running across a handful of devices. This is exactly what we should be doing—but remember how far away from production this stage can be.

Blockchain built for Bitcoin

Glenbrook partner and my colleague Russ Jones said to me “the best blockchain use case I’ve seen so far is bitcoin itself.” Bingo. The blockchain data structure and the cryptography that secures it is optimized for the open, permissionless nature of the bitcoin protocol. I could make the argument that we’re only now seeing interesting bitcoin uses now that third parties are using it within their own operations to effect value transfers.

This is going to take a lot of work

Reading through these articles and press releases, a common theme of technical experimentation emerges. Blockchain experiments are underway, testing the performance and scalability of permissioned blockchains built for specific use cases. There are plenty of applications where bitcoin’s 10 minute transaction confirmation timing is too slow, never mind its current inability to scale up in transaction volume. (We’ve spoken with developers testing blockchain designs capable of processing transactions at Visa-like scale, beyond 20,000 transactions per second.)

That’s as it should be. Every new technology needs to be thoroughly vetted to determine its optimum employment.

But the harder work lies elsewhere, in the domains of governance, rules development, regulatory change, back office optimization, and standards development.

Governance and rules

In our blockchain workshop, we make the point that the bitcoin protocol is rules-based. Its rules are enforced in software rather than by a contract or rule book. New block creation intervals of 10 minutes and the 21M bitcoin maximum are examples of its rules, each choice made and defined by human beings. Subsequent rule changes impact not only the system’s functions but the philosophical and economic lives of those affected.

The current division within the bitcoin development community over expanding the size of each block, in order to accommodate today’s higher transaction rates, is an example of the challenges that governance and rule change represent. Bitcoin adherents have celebrated the protocol’s lack of a central authority as a signal characteristic and advantage. While that may be true at the level of each bitcoin transaction, the keepers of the code are a de facto central authority responsible for rules evolution. Their governance struggles could limit bitcoin’s future. The wide open, largely permissionless internet succeeded because of rules and standards that evolve to address changes in the environment. Bitcoin, or its successors, can be no different.

The same need for rules and clear governance holds true in the domain of permissioned blockchains, where a closed group of parties, such as a collection of financial institutions or asset traders, transact among themselves. While satisfying the needs of a limited set of participants may constrain rules scope and governance complexity, it would be foolish to underestimate the difficulty of getting even a small community to agreement. After all, most are composed of competitors looking for advantage over one another.

Regulation

We’ve all observed how local, state, and national regulations struggle to keep up with technology-driven change. Uber’s multi-jurisdiction confrontations is just one example. As blockchain applications and smart contracts spread into traditional custodian-based businesses such as bank trust departments, law firms, and insurance, expect similar push back from incumbent businesses and the regulators guiding them. Regulations that grow over decades like the U.S. Uniform Commercial Code don’t change overnight.

Back office applications

Many blockchain startups are looking to automate back office functions of enterprise scale business. Most know something about blockchain and very little about the back office functions they propose to support. Complex back office processes make the maths of blockchain protocols look straightforward. Blockchain proponents could well heed Abraham Maslow’s caution:“I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.” In the back office, an entire tool chest in the hands of process craftspeople is what’s required.

Standards development

The internet succeeded because smart people came together to write standards for email, FTP, HTTP, DNS and the other tools that form its foundation. That foundation has enabled the innovation we enjoy today largely because it is not proprietary to an individual company or platform. The future foundation of bitcoin and/or its permissionless successors should be built along similar lines. The Linux Foundation’s Hyperledger project is an example.

Be critical

At its simplest, we can think of a blockchain as an unalterable ledger, a permanent database of transaction flows. Just remember, database technology is already highly evolved. While there are plenty of functions that could be served by a blockchain, record keeping functions for example, such uses have to be demonstrably better than current database tools to win.

So when you see the next flurry of blockchain stories, keep in mind that the technology of blockchains could be the least of the challenges.

Let me know your thoughts!

This post was written by Glenbrook’s George Peabody.

 

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