Banks and the blockchain just got closer

Last week a consortium of 11 banks trialled a blockchain experiment: they sent tokens to each other on a distributed ledger. You’re probably thinking that this sounds simple. You’d be wrong. It’s taken months of work to build the underlying structure and to test the security. And it seems like it’s finally paying off.

by Phillipp Henzler for Unsplash
by Phillipp Henzler for Unsplash

The work has been done by the group led by blockchain developer R3CEV, which in mid-2015 started to “recruit” banks to help it develop blockchain standards for banking applications. The philosophy is that bankers know best what bankers want, so why not involve them in the development process from the beginning, in exchange for the right to use the result? It makes sense, right?

The level of interest even surprised the company itself. From a base of 9 banks signing on in mid-September, it rapidly grew to 42 banks by the end of 2015, when it closed the window of admission. Among the participating banks are big global names such as Barclays, UBS, Bank of America, Banco Santander, Goldman Sachs, Citibank, Deutsche Bank, HSBC, Société Générale and Morgan Stanley, to name just a few.

A few days ago 11 of the members simulated the exchange of value on a ledger without a centralized authority, by sending tokens back and forth. The tokens represented theoretical assets, and the experiment aimed to show that the transfer of securities could be done instantly, securely and at low cost. All of the transferred tokens arrived at their test destinations intact and instantly verified by all nodes. The experiment worked.

Additional simulations with additional members will take place over the next few months, and the process will be adjusted to include different types of assets and settlement methods. This trial used Ethereum as a blockchain base, but R3CEV has specified that it is also experimenting with other ledger technology. The company is not revealing details about further experimentation, but has indicated that their attention in 2016 will widen to include non-banking institutions. Does that mean government organisations? ONGs? Transnational support?

We’ll no doubt hear more about this over the coming months, and it serves as further indication that 2016 will see the roll-out of important and far-reaching use cases for ledgers, the blockchain and for bitcoin.

from xkcd
from xkcd

Getting so many big names in banking to collaborate on a transfer structure that harnesses the technological advantages of the blockchain without depending on bitcoin (which would technically make it not the blockchain but a blockchain-inspired ledger) is exciting and encouraging. It’s a big step towards making the legacy banking and trading systems more efficient and transparent. However, banks being fairly cautious animals by nature, many are also experimenting with the blockchain on their own account, either with in-house teams, or in collaboration with other blockchain developers such as Digital Assets Holdings, Chain, Symbiont and Ripple. Confusing? Sure. But the interest is there, work is being done, and it’s not a winner-take-all situation.

The blockchain and the stockchain

At the very end of last year, a major milestone was reached in the bitcoin world. Or it wasn’t, depending on who you listen to. And what your definition of “stock” is. Either way, what happened was a big step forward, and a harbinger of important changes coming to securities trading and business finance.

What happened is this: Chain, which specializes in enterprise blockchain platforms, issued shares on Nasdaq. Only they weren’t traditional shares, they were digital. And not on the “regular” Nasdaq, but on a subsidiary newly created to handle this kind of transaction.

stock exchange

But how does that work?

Nasdaq Linq, part of Nasdaq Private Markets, was set up to facilitate the issuance, transfer and settlement of shares of privately-held companies on The NASDAQ Private Market using a digital ledger technology similar to that which powers bitcoin. (For more on the difference between bitcoin and the blockchain, see here.) Rather than a stock exchange mirror, Linq is more a shareholding management tool, especially useful for de-mystifying the chaotic structures thought up in the early days of a business. The ledger allows settlement time to be slashed (minutes rather than days), issued shares to be easily tracked, and related documents to be dealt with and executed online.

The mechanism was developed by Chain, so it is appropriate (or symbiotic, if you prefer) that its own securities be the first to try it out. Chain creates Nasdaq’s Linq platform, Nasdaq owns part of Chain, Chain is the first to issue shares using this technology… You get the picture.

Yet Chain won’t be the last to use this technology. Nasdaq has hinted that further digital share offerings are in the pipeline from ChangeTip, PeerNova and other blockchain startups. NXT, Ripple and Digital Assets Holdings, among others, are working on similar technologies, and we will definitely see several more transactions of this type over the next few months.


And depending on your definition of “security”, it wasn’t even the first. In August of last year, smart contracts platform Symbiont sold its own digitized private equity on the blockchain to an investor, and registered its founders’ stakes as well as stock options and shares granted to employees. Symbiont’s innovation is the creation of “Smart Securities”, which not only settles and records transfers, but can also pay dividends and convert stock options automatically.

Broadening the definition a bit, in June of last year US-based retailer Overstock sold a $5m “cryptobond” on its tØ blockchain-based security trading platform. In December it got regulatory approval for the issue of company shares on the bitcoin blockchain.

Whoever came first, all three innovations stand to make a big impact: Overstock because its tØ platform and upcoming digital share offering “proves that cryptotechnology can facilitate transparent and secure access to capital by emerging companies”, according to founder Patrick Byrne; Symbiont because it is leveraging the decentralized power of the bitcoin blockchain to make trades cheaper, faster and “smarter”, which will expand the use cases for bitcoin and open up trading to non-market players; Nasdaq because it is a globally recognized name with exchanges around the world. All of them increase efficiency by reducing settlement time, increasing transparency and removing middlemen.

This is exciting, but at the same time fraught with significant obstacles.

One is the inherent conservatism of investors. New technologies can be scary, especially ones that are not easy to understand. Institutions are used to the delayed settlement systems currently in place, and could well prefer to bear the steep economic cost of that inefficiency rather than risk not only losing their investment due to a tech malfunction, but also of looking foolish.

Another is the lack of understanding of the mechanism on the part of the private companies, and the fear of attracting the attention of the regulators. Especially in the US, where each state has different securities legislation, a non-physical security residing in “cyberspace” is too much of a conceptual leap for most funds and investors to feel comfortable with.

Another is the need to balance the open nature of the blockchain with investors’ need for privacy. What some might see as an advantage – the ability to track the ownership history of a share or bond – others might see as an encroachment on their desire for anonymity.

Yet these obstacles can be overcome with time, just as other technology adoption obstacles have been overcome in the past (remember the “no-one will use the Internet” prediction?). The advantages of blockchain-based securities settlement are clear: faster, cheaper and global. The need for simpler financing is also clear: initial cap tables and shareholding structures are usually a mess, scribbled on napkins and promised in meeting rooms. A secure and inexpensive method of issuing shares will make setting up a business easier, which could help to foster entrepreneurial activity. And as more and more high-growth startups avoid regulation-heavy IPOs, a reliable and liquid alternative will empower businesses of all sizes and make them less beholden to Wall Street and its international counterparts.

Who will be the winner here? Which business model will triumph? Will shares be on private ledgers or the public blockchain? I expect we will see a combination of forms and formats, with various platforms offering different advantages, with smaller businesses benefitting from enhanced control and transparency, and with an explosive growth in creative instruments backed by cryptography and maths.

It won’t be a smooth transition, and it won’t be quick. Nor should it. When it comes to investors’ money and companies’ financing, care needs to be taken. But the shift will happen, and as it does, it will lead to a more accessible and fair financial system.

Bitcoin in Africa? Not yet.

I was going to write about how bitcoin could help to improve economies in Africa through its efficient and low-cost secure method of transferring money. But after doing a fair amount of research, and realising that many of the companies mentioned in the press over the past year as being the “hope” of the future have since closed down, I’ve changed my mind. Instead, I’m going to write about how hard it is for a bitcoin-based company to do business in Africa. It’s not impossible – there are some success stories. But the advantages of bitcoin at this stage are not as obvious as they might seem. The theory is excellent. But the reality is complicated.

Photograph by Robin Hammond for National Geographic
Photograph by Robin Hammond for National Geographic

First, let’s talk about the promise. According to the World Bank, 66% of adults in Africa do not have a bank account. They deal in cash and in barter, with considerable lack of efficiency and security, and scant possibility of escaping that hand-to-mouth cycle. With bitcoin, they could effectively have a decentralized bank account and manage their finances more carefully, with control over what comes in and what goes out. Families could start to save and even lend. Payments would become easier and cheaper, leading to significant savings in both time and money. Current mobile money payment systems are efficient, but have a high fee structure. Bitcoin’s decentralization and security could economically empower those that are traditionally at the margin of the economy.

The ease and low cost of sending bitcoin anywhere around the world makes it the potential saviour of remittance services. Approximately $53bn was sent to the region in 2015 by workers abroad, with fees averaging 12.4%. Remittances cost more in Africa than in other areas – the world average is 7.8%. There are five remittance “corridors” (flows between two countries) in the world with fees over 20%, all of them in Africa. Using bitcoin, the fees would come down drastically, with the savings going directly to the beneficiaries.

The potential is huge. But the reality is very different.

Bitcoin has limited end uses in Africa. Very few merchants accept it as payment, and it can’t yet be used to pay for utilities or public services. That will change, but slowly. Bankymoon, a South Africa-based blockchain financial services company, has developed smart electricity meters that can be topped up from anywhere with bitcoin.

To be able to buy bitcoins on an exchange, you need access to a computer or a smartphone. Relatively few Africans have that. It is true that the majority of the adult population has a mobile device, but only 15% have a smartphone. According to the International Telecommunication Union, only 37% of adult Kenyans had access to Internet in 2014. In Ethiopia, the figure is 2%. So, buying bitcoin is possible but not simple, and the number of exchanges that can trade local African currencies for bitcoin is limited. Most require an initial conversion to dollars or euros, which significantly increases the transaction costs.

So, buying bitcoins is not simple, and even if you receive bitcoins as a remittance from a family member or friend working abroad, changing it into local currency on an exchange is difficult. Those without a bank account would need to find an agent willing to exchange bitcoins for cash. They do exist, but their scarcity and the technology access required allow them to charge very high fees for the service.

And bitcoin as a remittance rail has competition. Innovative international payment methods are eroding the incumbents’ market share by offering much lower fees. In Kenya, for example, WorldRemit, Equity Direct, and even new e-cash services offered by incumbents Moneygram and Western Union can transfer money for less than 5%. Of course, the low fee structure depends on electronic transactions. Once cash is involved, the fees shoot up.

And regulation, or the lack of, is an important structural problem. Although Nigeria’s Central Bank has called for bitcoin regulation, no country has it in place or is even, as far as we know, working on it. Kenya’s Central Bank issued a warning in December against Bitcoin use, citing its unregulated status. Unregulated does not mean illegal, but it does create obstacles for bitcoin exchanges, wallets and payment systems.

Regional differences and market size are also a complicating factor. Kenya alone, for instance, is not a big enough market to attract the funding needed to reach profitable scale. According to IMF estimates, its GDP is roughly equivalent to Bulgaria’s, and significantly less than Luxembourg’s. Each country has its own currency and phone system, so compatibility issues are barrier to rapid continent-wide expansion.

On top of the “typical” problems that startups have to face, new businesses in Africa also have to contend with relatively poor connectivity, recruiting difficulties and electricity outages. Africa has always been a very entrepreneurial continent, but at the micro level. The cultural and logistical difficulties of setting up cross-border businesses; recruiting, training and retaining a qualified team; the general lack of political and economic stability; high interest rates; limited access to funding… These and many other factors make the launch of scalable, profitable enterprises even more challenging.

In May of last year, Disrupt Africa ran a story on “5 African Bitcoin Startups to Watch”. Of the five, one shut down, one pivoted away from bitcoin, and one has had a major payment ramp blocked. Further digging uncovers several others that have closed down, and the bitcoin sector is littered with tombstones of good ideas that came to market a bit before their time.

And yet, bitcoin’s time in Africa will come, and its effect on the continent’s economy will be significant. Some remarkable businesses are struggling hard to make this happen. The use cases are much clearer there than in Europe or the US, where credit cards are ubiquitous and mobile payments are easy. The impact it can have on people’s lives is much greater. With persistence and brave first-movers, with rationally enthusiastic public comment and constant dialogue, regulators will see the economic advantages of further encouraging financial innovation. Tech hubs are springing up all over the continent, creative entrepreneurs are attracting international interest, and a lot more than transaction fees is at stake.

Bitcoin vs. the blockchain

The terms bitcoin and blockchain get used interchangeably way too often, which hampers understanding of the potential. So let’s clear up the difference.

Bitcoin, as you no doubt already know, is the name given to the decentralized virtual currency invented in 2008 by the mysterious Satoshi Nakamoto. A few iterations later, it has reached a market cap of almost $7bn and is used for purchasing, service payments, trading and for sending money around the world in a quick, secure and low-cost manner. The term bitcoin refers interchangeably to the system (usually capitalized, as in Bitcoin) and the currency itself (usually lower case, as in here are some bitcoins).

The blockchain is what makes Bitcoin secure and decentralized. It is a public ledger of all bitcoin transactions that have ever been executed. Transactions are grouped into blocks, which then pass through a verification process, part of which includes an identifier from the previous block. Once validated, the current block is added onto the previous block, forming a chain. Because each block contains encrypted information from the previous block, it is almost impossible to change the previous block without also altering the current block. It is even harder to change information from a few blocks ago, as that would involve also changing every subsequent block, and with the current encryption systems, that would take millions of years. (For more on how Bitcoin works, see here.)

Bitcoin can’t exist without the blockchain.

But can the blockchain exist without Bitcoin?

by Maya Karmon for Unsplash
by Maya Karmon for Unsplash


This is a subject of heated debate, with innovators creating blockchains without bitcoin, and with purists claiming that those aren’t technically blockchains. Let’s take a look at the two arguments:

A significant part of the Bitcoin mechanism involves the successful validation of transaction blocks. This takes time, specialized hardware and a lot of electricity, all of which incur costs. To compensate and incentivize the validators, known as “miners”, a bitcoin reward is automatically produced when a block is added onto the chain. Without this reward, there would be no-one able to do the work and the system would collapse. Even if a very wealthy volunteer decided to finance his or her mining/validating operation out of his or her own pocket, just because, he or she would have few if any collaborators, and the system would no longer be decentralized. So, technically, the blockchain can’t work without bitcoin.

Non-bitcoin blockchains do exist, but they tend to be centralized. Usually run by banks, corporations or as academic experiments, the incentive for the validators is strategic, not commercial. Their “reward” is operational efficiency, cost reduction or even just additional blockchain experience. Also, often in “private” blockchains the validation does not need to be restricted or difficult, so the costs incurred are much lower. In these cases, the bitcoin incentive is not needed. But the system is not decentralized, and is therefore vulnerable to manipulation and attacks. Purists insist that while they may be chains of blocks, they are not part of the blockchain.

De-centralized non-bitcoin blockchains also exist (such as Ethereum), but they use a different virtual currency instead of bitcoin (such as Ethereum’s currency ether). Same principle, different names.

Now, it is true that bitcoin is not the blockchain’s only potential application. Far from it. The public blockchain can be (and is being) used for recording information, transmitting documents and verifying ownership. But it still needs some element of bitcoin attached as a transaction fee.

We will no doubt see increasing activity in the blockchain space, both private and public, with broader use cases and deeper applications. The distance between private and public blockchains will continue to widen, as experimentation increases and as “permissioned distributed ledgers” become common corporate fare. For true decentralized, permissionless and secure distribution, however, the blockchain, the original one, will continue to develop and to grow, overcoming obstacles, volatility and confusing reporting. It will probably even outgrow the currency that it was created to support. To do so, however, it will continue to need a virtual currency such as bitcoin. Like all long-term relationships, the dynamics will adjust to experience and technology. But the relationship will last.

Kenya vs. Bitcoin

Over breakfast on December 15th, readers of the main broadsheet newspapers in Nairobi were greeted with a full-page ad taken out by the Central Bank of Kenya, warning them about dealing in bitcoin. The public notice was also posted online.

This is in equal measures surprising, disappointing and encouraging.

The main surprise is in the timing. The day before, the Kenyan justice system decided to postpone a ruling on the lawsuit brought by bitcoin remittance company BitPesa against the mobile payments giant M-Pesa for intimidation and unfair business practices. M-Pesa had blocked access to its platform, citing as the reason BitPesa’s unregulated status. Bitpesa claims that the Central Bank told them that bitcoin fell outside their remit, and therefore they could not offer a license. The decision, which allows M-Pesa to continue to block access to the main mobile money platform in East Africa, not only denies the convenience and economy of bitcoin remittances to a significant portion of the rural population. It also highlights the absurdity of trying to get a license, being told that licenses are not available, and then being punished for not having one.

While in theory the Central Bank does not influence the justice system, and the government does not control the Central Bank, the timing of the announcement in the newspapers can be interpreted as an indication of which way the government would like the courts to rule. For a fairly modern government battling increasing concerns over deepening corruption, this level of public “intervention” is perplexing.

Another perplexing aspect of this public approach is the list of warnings about bitcoin, and the subliminal messages they contain. The first one reads:

“Transactions in virtual currencies such as bitcoin are largely untraceable and anonymous making them susceptible to abuse by criminals in money laundering and financing of terrorism.”

Putting bitcoin’s untraceability and anonymity first and foremost as a help to criminals will surely attract the attention of even more criminals (or at least those that read the newspaper), and could possibly increase rather than decrease bitcoin use. BitPesa does follow KYC/AML guidelines to prevent money laundering and terrorist financing, but other less high-profile exchanges may not be so rigorous.

The second warning claims that bitcoin exchanges “tend to be unregulated”.

“Virtual currencies are traded in exchange platforms that tend to be unregulated all over the world. Consumers may therefore lose their money without having any legal redress in the event these exchanges collapse or close business.”

While not untrue, it is misleading. Some regulated exchanges do exist (Coinbase, Gemini, itBit), many more are in the pipeline, and many others, while not officially regulated, behave as if they are. Often it’s not that they don’t want to be regulated. It’s that they can’t, as there is no regulation in place. Such as in Kenya, for instance. BitPesa complies with KYC/AML regulations, yet is being treated as if it didn’t.

And the third warning, pointing out bitcoin’s vulnerability and volatility because there is “no underlying or backing of assets”, will surely draw attention to the fact that there is no underlying or backing of assets on the Kenyan shilling, either, other than faith in the economy (doing quite well) and the government (not so much).

Political mistrust is a strong motivator in bitcoin use, and the Central Bank’s request that the public “desist from transacting in Bitcoin” could have the opposite effect. With a fragile democratic stability (the current president took power with only 50.07% of the popular vote in the 2013 elections, and is currently under investigation by the International Court of Justice for crimes against humanity), and with increasing political violence and concerns about corruption, many readers of the major newspapers could well take an official call to refrain from using bitcoin as an open invitation to try it out.

Kenya vs bitcoin

The disappointment comes from the closed-minded approach to financial innovation, from a government that has a reputation for encouraging it. In its early days M-Pesa was not required to comply with complicated and expensive regulations, which allowed it to grow rapidly and inexpensively, creating efficiency and opportunity, as well as a near-monopoly on mobile money transfers. Although it has increasing competition, its extensive network and brand mindshare still give it considerable power in the sector, which enables it to maintain the relatively high transfer fees. Lower fees from a more nimble competitor would benefit the recipients and the economy, while technology and scale bring costs down. Lower profits for M-Pesa, perhaps, but greater wealth for Kenya. Bitcoin-based services can complement the established mobile money networks by expanding their reach and broadening their client base to include remittance senders from all over the world. Trying to limit participation to competitors with less potential is short-termist and damages the incumbent’s reputation.

However, it is encouraging that the Central Bank deemed bitcoin important enough to issue a public statement. In so doing, it has called attention to the digital currency: no doubt most of those that saw the ad hadn’t heard of bitcoin. Now they have. And while it is important that those interested in buying bitcoin be aware that it is not government-backed, all who investigate further will start to realise the opportunity that it presents.

This announcement could be a first step towards regulating bitcoin, which would be positive for the sector (although why the Central Bank didn’t just issue a statement about contemplating regulation instead of advising against bitcoin use is a mystery). It would also be in line with an incipient regional trend. In August of this year the Nigerian Central Bank called for bitcoin regulation, and an increasing interest in Bitcoin conferences on the continent indicate that other nations are contemplating doing the same.

Trying to wipe out bitcoin use makes no sense, especially when the economic advantages are so strong. Harnessing the opportunity, establishing regulation to protect users and limit illicit use, and incorporating a global virtual currency into an economy already heavily dependent on mobile-based local virtual currencies would increase economic activity, encourage saving and bring even more of the population into the virtually banked sector. And it would entrench Kenya’s reputation as a regional technology hub with an innovation-friendly government. Kenya has a lot to lose if it tries to stamp out bitcoin, and a lot to gain if it cautiously supports its integration into the already strong virtual economy.