Can there be a blockchain without bitcoin?
A blockchain refers to a public ledger in which the latest block, itself comprised of unfiled transactions, is added chronologically as the last ledger page, so to speak. Once a block is added to the blockchain, all transactions within are immutably recorded. In this way, the ledger represents a final and irreversible settlement of accounts. Blockchain technology could thus be enormously beneficial to banks and other commercial entities, who literally spend billions and billions of dollars annually on a settlement process that a proper blockchain could, theoretically, manage for free.
Bitcoin is the most well known blockchain technology. Generally speaking, when one thinks of bitcoin, they most likely view the blockchain as necessary to support the currency – it is meant after all to provide an accounting of how bitcoin itself moves from account to account. However, when looked at in the context described in the first paragraph, this perception is flipped upside down. Bitcoin, far from being the purpose of the network, is there simply as the means to incentivize the miners responsible for settling transactions. Yes, it is essential for bitcoin to have value because otherwise the miners would have no reason to mine. But that value is required only to support the blockchain; it is not the other way around. Bitcoin maximalists, for lack of a better term, would argue that bitcoin and that mining mechanism is absolutely essential to secure a blockchain.
This point of view is being challenged by a new type of blockchain currently the rage in the grand halls of fintech, the poetically named tokenless permissioned ledger. Tim Swanson, general cryptocurrency specialist and advisor to hyperledger – a company offering this form of mining-less blockchain – offers the best argument for choosing such a mechanism over bitcoin in his article “Needing a token to operate a distributed ledger is a red herring“.
Banks, he argues, are not concerned with censorship resistance and anonymity, which he tags as the modus vivendi of bitcoin and the main reason for its extremely expensive mining mechanism. “If you do not need censorship resistant as a feature, then you do not need proof of work…if you don’t need proof of work, you don’t need a token to incentivize validation or secure the network”. Additionally, banks don’t want bitcoin’s anonymous mining network, which could be a regulatory risk. What banks want – and what hyperledger and others delivers – is a closed blockchain network with settlement enforced by “known validators [nodes] with real-world identities and reputations”. Hyperledger, then, allows banks to avoid having transactions settled by unknown entities based who-knows-where, and avoids any messy regulatory – or even reputational – hurdles that might emerge from utilizing bitcoin (Mr. Chairman, how did this bitcoin that was used to buy drugs on OpenBazaar end up supporting your banking transactions?!).
A counterargument to Mr. Swanson is found in an article written for American Banker by Chris DeRose. Mr Derose provides an interesting description of the shortcomings of non-censorship resistant Ripple, shortcomings that could be just as easily ascribed to tokenless permissioned ledgers as well. Both Ripple and Hyperledger replace bitcoin’s decentralized consensus mining mechanism with more centralized methodologies (Nodes are – sometimes more, sometimes less – distributed, but there are centralized dependencies). As far as it pertains to Ripple, this centralized method “has exposed the entire network to risk in the form of an easy point of failure and censorship. This has resulted in the recent and very embarrassing court-ordered freezing of funds for one large digital currency exchange, as well as an anti-money-laundering fine levied by FinCen.” Essentially, the Ripple network has very well-publicized single points of failure that can be targeted – in this case by benevolent forces like FinCen – but assumedly also by unknown malevolent forces to shut down or compromise the network for whatever purpose.
Unlike Ripple, Hyperledger means for organizations themselves to establish, with a convenient toolkit, bespoke blockchains. These same organizations would also have the power to alter the original mandate – or what is written in the ledger – as required. The blockchains are meant to be secured by three nodes, entities that would be legally and contractually responsible for validating transactions. Malicious nodes would be expelled through some blacklisting mechanism defined by the ledger owner(s).
It remains to be seen whether a closed network of banks might indeed trust the veracity of the issuer and participants. It does give rise to a potential conflict in which a minority of the network objects to some alteration of the original mandate pushed through by the majority.
More importantly, they might be concerned as to the ability of the nodes or the blockchain itself to withstand malicious attacks. And this is the strongest argument for using the bitcoin blockchain – how can one be sure that a tokenless distributed ledger can be properly secured? – and this is an argument not adequately addressed in Mr. Swanson’s article.
Mr. Swanson notes that bitcoin’s security comes at a cost, as the network “funds mining operations to the tune of $300 million a year”. It is difficult to understand why this is construed as a negative. That $300 million in cost is absorbed by the miners in pursuit of newly minted bitcoin, which is viewed at least by them as having greater worth. As far as the banks should be concerned, there is a ready-made network with seven years of real world high-volume stress testing that has $300 million annually invested in its security. It is engineered and improved by the best developers in the industry. And it is more or less free to use. Hyperledger’s, though also free to use, does not boast the same security backing.
Of course, banks and other financial institutions might view these concerns as less…concerning than other potential regulatory issues described above. There will be more clarity on bitcoin regulation as time passes, and it seems that governments are seriously working to define their positions. Meanwhile, the market is moving forward, with some serious companies experimenting with the bitcoin blockchain, while others are partnering with alternatives.
Whither the Blockchain Market?
Nasdaq has recently announced its partnership with San-Franciso-based-startup Chain to test the bitcoin blockchain in a pre-IPO marketplace for private companies. Small fractions of bitcoin would effectively be stamped as corresponding to a share of a particular stock. Trading of these stocks would take place on the bitcoin blockchain, along with standard bitcoin transactions.
Westpac Banking Corp, the Australia and New Zealand Banking Group (ANZ), and Commonwealth Bank of Australia, three of the four largest banking groups in Australia, are experimenting with the Ripple protocol to transfer payments between subsidiaries. The Australian Financial Review quotes a spokeswoman saying this about bitcoin specifically: “regulators globally are currently reviewing bitcoin and other cryptocurrencies to better understand the technology and possible implications, and we would need to see the outcomes of any review before confirming future plans”. In other words, until there is a clear regulatory stance, the banks will not utilize bitcoin despite the fact that, at least in the opinions of many, it presents a superior solution.
And then there is Hyperledger, which recently was catapulted into the limelight after their acquisition by Digital Asset Holdings. Their mission is to “reduce settlement latency and counterparty risk [by providing] tools that use distributed ledgers to track and settle both digital and mainstream assets in a cryptographically secure environment”. While not a new concept, the company team is what is most interesting. CEO Blythe Masters, inventor of the default credit swap (not to be confused with the people who eventually misused the instrument) is considered one of the most powerful women on Wall Street. She joins founders Donald R. Wilson and Sunil Harani, both of whom have amassed upper 9 figure fortunes and unparalleled connections in the world of finance.
Ms. Masters’ has made statements suggesting a belief in the essentialness of a token for blockchain security. “We don’t think of bitcoin as being a store of value or an alternative currency or an investment,” she said in a recent Wall Street Journal interview. “We think of it as a medium for exchange and a mechanism for recording information.” Storing information on the blockchain would be facilitated in much the same way as Nasdaq intends, through the association of a real world asset with small fractions of bitcoin. (UPDATE: Ms. Masters has backtracked pretty hard on her bitcoin support, and now essentially says to focus on the blockchain and to forget about bitcoin).
It will be interesting to see how DAH will eventually use Hyperledger, whether it ends up representing part of the company’s core strategy or simply becomes a seldom used risk diversification. What does seem certain is that banks and other financial institutions are looking to revolutionize previous models and to replace them either with bitcoin technology or those technologies which it has inspired.