It’s not about Bitcoin, it’s the blockchain stupid

SUMMARY:

Bitcoin’s ups and downs are well documented but that isn’t the real disruptor. It’s the blockchain.

bitcoin julioA couple of weeks ago I stumbled across a piece showcasing UBS’s CIO, Oliver Bussmann. He is quoted as saying:

“Our innovation lab at Level39 will provide a unique platform to explore emerging technologies such as blockchain and cryptocurrencies, and to understand the potential impact for the industry.”

The article and its derivatives piqued my interest at several levels.

First, I know Bussmann. He’s wicked smart and an assiduous user of social media. He did an outstanding job at modernizing chunks of SAP and introducing thousands of iPads into what was a wall-to-wall IBM/Lenovo environment. Anyone who can pull that off in a company like SAP gets a big thumbs up from me. So when he talks in these terms, I want to understand what he’s saying.

Second, I’ve been quietly following the Bitcoin story for a while. It’s not easy to understand, even for someone like me who has had international finance related roles. I don’t think the story is made easy by the arcane use of unfamiliar terms or the naming convention of ‘crypto-currency.’ Sounds like something alien – right? Far better to simply term Bitcoin as a digital currency.

Third, while much of the focus has been on headline grabbing stories like the illegal drug selling site Silk Road, the Mt Gox collapse, early regulatory failure and the like, investment has been pouring into technologies surrounding Bitcoin and the blockchain in particular.

When the pieces fall into place then you quickly see that the blockchain could upend the financial systems of the world as we know them. But hang on – what’s this blockchain thing?

What’s the blockchain?

blockchainLast year, our own Phil Wainewright took a tilt at this, I’m taking this half a step further.

Blockchain is another of those weird terms that sounds like a method of shackling prisoners when in fact it is the opposite. It’s a geeked out composite word meant to be descriptive of how the blockchain works. Right now, the technicalities don’t matter, it is what it can do that matters.

At its simplest, the blockchain is the fully decentralized global ledger used to record all bitcoin (or digital currency) transactions. In book-keeping terms it is a vast open ledger that anyone with the right technology can mine. In technical terms, the blockchain represents the infrastructure upon which Bitcoin exists and through which Bitcoin is mined for profit.

This has a LOT of advantages over existing financial infrastructures.

It doesn’t matter if Bitcoin dies because at its heart, Bitcoin is a digital technology that is fully open sourced. You can go get plenty of code at GitHub.

I’m with Dominic Frisby when he said in January:

I do think that bitcoin, or one of its off-shoots, will eventually become the global standard for online transactions. And I think it will have a role to play in bringing unbanked people in developing markets into global commerce.

The problem is that we’ve heard all this before. Digital currencies are nothing new. Anyone remember e-gold? Like some of the early forays into Bitcoin’s surrounding markets, it fell to hackers, fraud and…regulation, a triumvirate that sounds very familiar today. You can argue that e-gold was the forerunner of PayPal which has its own turbulent history but which has since spawned a slew of innovative ventures.

Blockchain impact

UBS venture into this arena is interesting. They are the latest of a string of banks to take a shot at incubating for the blockchain. This matters a great deal because one thing the blockchain can do which banks are notoriously slow at is – you got it – transaction processing. Done right, the blockchain acts instantly. Gone would be the days of waiting while money sloshes around the financial system.

The potential impact is huge, hence bank interest (sic). Think of it this way. Each day there are trillions of dollars, yen, British pounds, you name it, swilling around the global banking system. Someone’s lending that money and someone’s borrowing it because even if it is not credited as cleared to your account, the holding bank can still make money from it on overnight deposits.

In monetary terms and assuming a 0.5% interest rate spread, financial institutions are making $13.7 million PER DAY for every trillion dollars floating around in the system. Readers can work the math on other rates and amounts. If you factor in payment fees running 2-5-3.75% then blockchain operated payment transfer methods that charge a ‘mere’ 1 percent start to look very attractive to small business and the unbanked.

Turn that notion into a single, global digital currency that’s accepted as a token of value in exactly the same way your dollar bill is accepted and it’s a small hop to global financial market disruption and massive efficiency gains in the cumbersome financial supply chain.

It is that combination that makes the case for blockchain technologies so appealing and explains $349.03 million that was poured in as investment in 2014 and $229.34 that has been invested to date in 2015.

Unfortunately it’s not all plain sailing and my sense is that we’re entering the end of the beginning which saw Birtcoin blossom as a digital currency in 2011-13 but which since has had a very rocky ride.

Confusion abounds

Despite the enthusiasm, there’s still plenty of confusion in the general market.

In December 2013, Bank of America Merrill Lynch claimed: 

Bitcoin may “emerge as a serious competitor” to cash in e-commerce and digital money transfers.

A year later, the bank was saying:

In a continued attempt to compartmentalise BitcoinDavid Woo, the global rates head at Bank of America Merrill Lynch appeared on an episode of “Bloomberg Surveillance” where he espoused the use of Bitcoin the payment system while writing off bitcoin the unit of account as something one should not invest in.

That kind of thinking is inevitable when the technology is so inextricably linked to a currency that is so volatile. It isn’t stopping the smart money from continued investment as noted above.

My take

  • Financial technology is one of the great largely untouched areas of commerce that is ripe for disruption. People are asking too many questions about the fees that are forced upon them by the banks. The banks operate archaic systems that a cynic (like me) might say works well to oil the wheels of profit and loss accounts but which will be seriously threatened by digital financial technology.
  • UBS is sounding the warning bell – others will follow.
  • As Phil Wainewright alludes in his piece last year, it may take many years for blockchain related technologies to bear significant fruit.
  • Regulation moves very slowly in the financial world, and while we hear the excusers of ‘risk and governance’ technology will not stand still.
  • The inexperience of the past won’t be carried into the future and my guess is that regulators will wake up to find themselves adapting out of necessity, not desire.
  • The possibilities and potential for blockchain technology are extraordinary at every level of business and society. If you’re not keeping up then you should.
  • The global banks will want to ‘own’ this technology set but for as long as the blockchain remains as open source then nobody owns it.

Endnote: I just noticed that NetSuite has an add-in for BitPay – nice.

Disclosure: NetSuite is a premier partner at time of writing.

    Comments are closed.

    1. says:

      Hi Den,did you have a chance to watch bitcoindoc.com yet? it’s a great documentary on the early days of bitcoin and you can almost sense a pioneer spirit among its early users. one of the founders hails from the neighborhood of your partner – Jon. in my mind, it’s an ‘imitation game’ of sorts, made for the modern times.the current bitcoin price oscillates around $200-250, so it’s only a fraction of $1,000+ quoted of last year. i agree that the actual concept is very arcane and requires some high math (which shouldn’t be all that hard for some of the finance types, btw). prime number factorization and one-way functions come to mind. another part is of course computing power which bitcoin, or any other similar currency, mining consumes, so it’s hard to expect a personal edition any time soon. hence, you have the heavyweights  like Microsoft and IBM, either already accepting or dabbling with central banks to harness the cryptocurrency, respectively.it’s just a matter of time before we are all using it through our smartphones, so let me ask you again. do you know of a reputable investment house that makes bitcoin investing as least painful in terms of fees and fraud protection as possible? for those who need to file tax returns in the US, treasury regulations have designated bitcoin as property and not as currency, so your gains (and losses) can already be declared.happy bitcoinig!greg

      1. says:

        Thanks Greg – I didn’t see that but I did see The Rise and Rise of Bitcoin on Amazon Prime which was a largely neutral look at what happened right up to BitInstant’s collapse and the Silk Road arrests. It’s done mostly through the eyes of an early miner who’s in it for the long haul and looks to have been filmed over several years.

        Not sure I can help you on investment (I don’t own any stocks other than in diginomica) but there are plenty of resources out there to get you going. 

        Worth checking where the smart money is going. Check http://www.coindesk.com/bitcoin-venture-capital/

        1. says:

          i just checked, it seems to be the same movie and if you are calling it ‘neutral’ i think it’s a compliment. thx for the coinbase.info referral.

          1. says:

            Aaaah – OK. I didn’t see it as particularly biased but then I wasn’t looking fro bias. Certainly a fair attempt at documenting what happened. Such a shame it had to end where it did though because another 6-9 months would have brought interesting ‘balance’ to the overall picture.  

    2. Bit says:

      As defined on Wikipedia:”The block chain is a public ledger that records bitcoin transactions. A novel solution accomplishes this without any trusted central authority: maintenance of the block chain is performed by a network of communicating nodes running bitcoin software.”The main component and most ground breaking aspect of the block chain is the removal of trusted third parties and the creation of an immutable ledger. Until now all financial systems required trusted third parties, in so far as that a central authority controls and updates the ledger manually. In relation to Bitcoin the ledger is maintained by a global network of computers achieving consensus by calculating robust hashing algorithms. These hashes act as whats known as bitcoins and are used as the unit of account on the block chain. If you remove the bitcoins (the decentralized trust aspect) you remove the benefits Bitcoin has created and simply revert back to the legacy financial system that requires trusted third parties.All these concepts are explained in detail by Satoshi in the original whitepaper, https://bitcoin.org/bitcoin.pdfI would personally like to see more technical analysis of how block chains are possible or even useful without the decentralized incentive network in place to ensure that there are no central authorities controlling the network. So far I have only seen pundits parroting buzz words and very little scientific rigor. 

      1. says:

        Bit – thanks for that although I was hoping to avoid the technical discussion at this point in favor of thinking about the business benefits. All the same. 

        Have you seen how Ethereum is approaching this topic? https://www.ethereum.org – they note the limitations and weaknesses in the blockchain and take it forward several steps. 

        With more than $600 million pouring into startups that are leveraging the blockchain, investors clearly believe there’s significant mileage in at least testing alternatives. We are watching this carefully to see what develops but right now, the potential to unlock value in the financial supply chain is enormous. And when I see UBS, BBVA and BoA active then I know there’s something of value going on. 

        1. Bit says:

          Yes, but Ethereum also uses a unit of account known as Ether. This Ether is the fuel used to make entries on the decentralized network/ledger and it also has monetary value, just as bitcoins are the fuel for the Bitcoin network/ledger. These tokens not only act as hash functions to indpendently secure the ledger, they also act as incentive for people to participate in the network. What banks want to do is achieve all the benefits of the block chain while removing the token or replacing it with their own. Trusted third parties is the keyword here, if banks build their own block chains someone will certainly maintain the role of trusted third party, they have no choice as regulation will force them to do this. So again a trusted third party has control over the ledger and therefore removes the immutable aspect which Bitcoin has achieved. This is nothing new, our whole financial industry is based on this right now. The only reason cryptography and hashing is used with Bitcoin was to achieve decentralized trust, none of these components are inherently needed in traditional “trusted” financial networks. These banks are missing the point as to why decentralized trust networks were created in the first place (removing trusted third parties), their research committees will soon break the bad news to them.