PSD2 and the blockchain

by Diego Hernandez via Stocksnap
by Diego Hernandez via Stocksnap

Europe has some surprisingly progressive ideas about retail banking.

In 2018, the new payments directive (PSD2) comes into force. This will change not only how we see banking, but also how we treat data.

A bit of background: the Payments Services Directive was adopted in 2007 to create the Single Euro Payments Area (SEPA), aimed at simplifying and modernizing the rules and guidelines for money transfers within the European Union.

An update (PSD2) was passed by the European Parliament in 2015, with the goal of further promoting innovation while enhancing consumer protection.

That may sound good for the consumer and the fintech sector, but it makes banks’ current situation even more tenuous. The sector is already pummeled by low interest rates, increasing KYC/AML costs and flourishing competition. Now, it has to invest in further compliance, and watch while its main competitive advantage is eaten away.

What main competitive advantage? Access to your information.

After 2018, when PSD2 comes into effect, banks have to share your data with third parties.

For end users, this streamlines payments and lowers costs. For innovative businesses, it gives them instant access to a significant resource: specific and detailed information about potential clients.

Retailers will be able to ask you for permission to access your bank account – the payment will be directly between your bank and the retailer. No intermediaries. Investment services will have access to your financial history and be able to offer more tailored advice. Payment portals will be able to compete for the lowest fees and creatively combine financial and social functions. Aggregators will be able to display all your financial information in one place, regardless of how many banks you work with.

Just think how attractive all that data is for service providers.

(There’s some other stuff in there as well, such as tighter control on credit card charges, greater protection for non-EU payments, unconditional refunds on direct debits… all good news for the consumer, not so much for the banks.)

What does that mean for blockchain development?

Basically, PSD2 is about the sharing of sensitive data with a network. Right now, the law envisions the transfers being handled through Application Programming Interface (APIs), code that gives third parties access.

On a blockchain, the distribution could be handled in an open, seamless and secure manner. Banks, clients, retailers and fintech services could all use the same system to share information. Access would be limited to network participants (who would have to jump through some hoops to join), transparency would ensure good behavior, and decentralized storage would enhance security.

This has to be preferable to a system in which banks (reluctantly) cede the information to any approved entity. Or a system littered with targeted APIs with limited interoperability. Or one in which the information is stored in centralized (hackable) silos.

Furthermore, a blockchain-based system would have lower operating costs than a distributed database, since less verification will be needed each time the data crosses over to another platform.

Lower operating costs will be crucial, given the tightening squeeze on banks’ profit margins.

While banks are currently preparing for this seismic change on their current systems, the appeal of a blockchain alternative is likely to encourage even more research and pilots than are already going on. Incorporation of a decentralized, transparent solution may shift from being a nice-to-have, when-we’re-absolutely-sure option to an increasingly pressing imperative. While blockchain technology is still new and has many hurdles to overcome (not least, regulatory), and while the cost of implementation is likely to be substantial, the need to adapt to a new financial paradigm could well be the catalyst that the sector has been waiting for.

We could be on the verge of a shift in blockchain interest. Already high among banks, it could jump up a notch to imperative.


Does JP Morgan’s exit hint at changes at blockchain consortium R3?

red-exit-sign (1)

CoinDesk reported earlier this week that JP Morgan has officially exited R3.

This is not a surprise – last year when Goldman Sachs and Banco Santander left the banking consortium, rumours abounded that JP Morgan would stay out of the funding deal that R3 was trying to put together. Disagreement with the structure of the financing was one reason cited for the exit of the two large financial firms.

Speaking of the funding deal, you know, the one that David Rutter assured us would be completed in Q1 and would be biggest ever in the sector…

“We will be closing the largest round in the industry, with the largest number of market participants, now, in the first quarter.” (from CoinDesk, January 11, 2017)

Where is it? The first quarter has come and gone, and still no news. And then we hear that JP Morgan are leaving.

R3’s reaction is disconcerting. Managing Director Charley Cooper gave the following comment to CoinDesk:

“JP Morgan parted ways with R3 to pursue a very distinct technology path which is at odds with what the global financial services industry, represented by our 80-plus members, have chosen.” (from CoinDesk, April 27, 2017)

So, the “global financial services industry” (as represented by a mere 80 firms) has chosen a certain technology path? Do the tens of thousands of financial firms not in R3 know this?

And are they really comfortable with choosing only one path this early in the game? They are so sure that R3’s solution is the correct one? Whether they are or not, it’s R3’s assumption that they should throw all in with their solution that makes me splutter.

JP Morgan’s leaving is quite a big deal – it was a founding member.

Back when Goldman Sachs (also a founding member) and Santander left, my hypothesis was that they were backing away from consortia in general. Consortia are especially useful when investigating a marginal activity. When it becomes key, and when businesses feel that they know enough, it makes more sense to “go it alone” for competitive advantage.

JP Morgan, however, is active in both Hyperledger and the Enterprise Ethereum Alliance, and has contributed code to each. It’s not rejecting consortia as a concept. (Also, Santander since then has joined the Enterprise Ethereum Alliance as a founding member.)

So, it does sound like there were issues with R3 in particular. And it sounds like R3’s funding round isn’t going as smoothly as hoped.

Trying to enforce Mifid II could kill it

The FT reported yesterday (paywall) that the European Securities and Markets Authority (ESMA) has issued guidance toughening the rules on securities trading transparency.

Under the upcoming Mifid II rules, banks will no longer be able to offer clients fixed income products kept on their own books (which accounts not only for most fixed income trading in the market, but also for a large chunk of bank trading profits).

The new statement closes a loophole that would have allowed banks to band together to form “dark pools”, effectively trading securities on the books of other members in the group, without needing to go through pesky public exchanges.

ESMA has made clear that any such group would need regulatory approval.

The potential consequences of this clampdown (and all the others embedded in Mifid II) could on the one hand be positive: increased transparency is likely to push down bond prices and open up the market.

Or, they could be negative: rather than make bond trading more transparent, the market movers (mainly banks) could decide to curtail their trading operations, which could result in a less liquid market.

The potential negative impact could also be what ends up killing Mifid II implementation.

Why? Because of the power of the banks.

Let’s backtrack a bit: Mifid II is all about increasing the transparency of securities markets, and enhancing investor protection.

Equities are already mostly transparent. The same cannot be said of fixed income, where trading has traditionally been over-the-counter (OTC).

Banks dominate the fixed income market, where they make most of their money (allegedly due to the lack of transparency). As the deadline for implementation approaches, we could well start to see significant pushback from an influential sector.

Surely ESMA could tell the banks to shut up and behave? If you have small children, you know how that generally turns out. Any large bank could resort to the typical two-year-old defense of “I’m going to hold my breath until you do what I want”. And it’s unlikely that ESMA will want a messy bank failure on its hands.


Also, one of the largest purchasers of bonds in Europe is the European Central Bank, which has been buying fixed income at the not inconsiderable rate of €80bn a month (now down to €60bn). I doubt very much that they will be happy with a change that is likely to reduce bond prices, let alone one that could provoke a contraction in liquidity. There aren’t enough bonds to meet demand as it is.

Furthermore, a possible result of the clampdown will be a migration of the market for European bonds to the US, which has a more relaxed attitude to bank bond trading. Since a large chunk of Trump’s cabinet seems to be made up of ex-investment bankers, that attitude is unlikely to change any time soon.

Losing an important market to the US is not something that the various organizations with confusing initials that currently govern Europe are likely to be happy about.

So poor, beleaguered ESMA could well come under pressure to go easy on market transparency. But if it does, then Mifid II unravels. Parts of it could still be implemented, and brokerage houses and asset managers will still have to scramble to improve reporting and lower costs. But the essence, the need to increase market transparency to protect investors and to avoid a repetition of the financial crisis, will be tainted.

Investing in a central bank?

SARB 800

Take a look at this extraordinary news item reported by Reuters a couple of weeks ago: “South Africa’s central bank sells shares of investors deemed to have too many”.

The South African Reserve Bank (SARB) is putting up for sale 150,000 shares currently held by private individuals and institutions, in a move to prevent attempts to influence central bank policy. Apparently several shareholders have ignored the law that limits any individual holding or group of holdings to 10,000 shares.

Earlier this month, the bank invited South Africans to purchase the newly available shares, stressing that it wanted to diversify its shareholder base. The stock used to trade on the Johannesburg Stock Exchange, but left when it was unable to comply with changes to listing requirements. It now trades on an over-the-counter market coordinated within the Reserve Bank, and pays a dividend of a maximum of R0.10.

Which part do you find more astonishing? That we have a central bank marketing its own shares to the public? Or that it is even possible to own shares in a central bank?

If the latter, you’re not alone.

And nor is the SARB. The central banks of Switzerland, Japan, Belgium and Greece also list on local stock exchanges.

For an excellent summary, see JP Konings article from a while ago.

Back to South Africa. The marketing pitch seems to be based on patriotism, because the shares themselves aren’t that attractive. The yield is paltry (just over 3%), the dividend is capped, it is run as a not-for-profit, any profits go to the government and shareholders have no voting rights. And get this, you can only buy or sell these shares by sending your instructions “by means of postal, facsimile, hand delivery or e-mail communication only” (taken from the SARB website). So you do need to wonder, why would anyone buy them, unless it is in the hope of having some influence?

Why is this important? Because it underlines that most of us don’t really understand central banks. Just like bitcoin showed us that we don’t really understand money.

Just like being aware of alternatives to fiat money can help to bring about financial reform, being aware of different models of central banks will open mental doors to a re-imagining of the system.


Fraud and the jitters

by Jean-Pierre Brungs for Unsplash
by Jean-Pierre Brungs for Unsplash

All is far from well in the Chinese bond market. And the implications for blockchain technology are deep.

December was not a good month for bond traders. As if the deep slump in bond prices after the US Fed raised rates wasn’t enough, the market was also shaken by two major incidents of fraud.

In one case, the forgery involved papers in which a bank guaranteed a bond that subsequently defaulted. The bank said “not my problem” and refused to honor that guarantee.

In another case, it emerged that two rogue employees of a trading house called Sealand Securities had used a forged company seal to purchase, on behalf of other financial institutions, over 16 billion RMB (almost $2.4bn) worth of bonds. You read that right, “billion”. The bond prices fell, and someone had to make up the loss. Sealand said “not my problem”, the blame lay with the perpetrators, and why not, also with the correspondent financial institutions who “should have checked”.

In the end, Sealand agreed to honour the bond contracts, but the fright did not help market jitters. At least 29 bonds defaulted in 2016, up from 7 the year before. Over 117 billion RMB of sales were canceled or postponed in December, almost four times the amount in November. A government bond index fell 1.7% in December, the steepest monthly decline since October 2013. And with interest rates heading higher and economic difficulties ahead as leverage is reigned in and global trade becomes more, um, complicated, it looks like defaults will continue to increase in 2017.

Tighter regulation and controls could help to calm fears that fraud is making the system more vulnerable. Local media has reported that the government is contemplating the creation of a regulatory body just to focus on systemic risks.

Or, financial institutions could step up their investigations of blockchain technology applications.

On the blockchain, transactions cannot be tampered with, and fraudulent use of signing keys is instantly visible to network participants. An unalterable ledger of events would make accountability more transparent, authorizations can be more tightly controlled, and the falsification of ownership documents ceases to be an issue.

In other words, with financial settlement supported by blockchain technology, fraud would be much more complicated. The incentive would not just be for corporations. With enhanced transparency, government officials would be under greater pressure to clamp down on irregularities, especially given President Xi Jinping’s anti-corruption drive.

China’s financial institutions, tech enterprises, universities and startup community are active in blockchain innovation. The central bank recently announced that it was testing a blockchain-backed digital currency, with a view to using the platform for bank bill transactions.

The government, perhaps aware of the need for speed, is encouraging blockchain research and adoption. In October, the Ministry of Industry and Information released a white paper that explored blockchain applications, particularly in finance, and encouraged businesses to be more active in global experimentation. The same month, the government hosted a forum aimed at fostering cooperation in blockchain development.

Given the obvious need for a lasting solution, we can expect these efforts to intensify over the next few months. But will it be fast enough?

While blockchain-based solutions could restore confidence in the integrity of the bond market and open up channels of financing to a broader range of businesses, it is unlikely that any would be ready for the market in the short term.

The situation is verging on urgent, though, as a rapid build-up of leverage has made firms increasingly vulnerable to an economic downturn or even to a change in market sentiment. A looming trade war with the US, or even military conflict in the South China Seas, could be enough to trigger a string of defaults, which are likely to uncover even more fraud and misappropriated leverage.

The damage could be harsh, in an environment that would already be suffering from economic and geopolitical factors.

Bitcoin, central banks and irony

The idea of bitcoin and central banks joining forces is not quite as farfetched as it seems. True, bitcoin is a decentralized global currency system, and regional central banks are, well, centralized and regional. So, on the surface they have nothing in common, except for the objective of a fast, efficient, low-cost method of payment and settlement. The main difference between bitcoin and the central banks is in how they think that should be governed and executed.

What do central banks want? They want an efficient way of settling interbank trades. They want a healthy banking system. And they want to influence the economy by controlling both the money supply and the interest rates.

What does bitcoin want? It wants to empower individual users to control the use of their own money, free from intervention, manipulation and censure, and totally open to market forces.

Could central banks use bitcoin’s technology to achieve their goals? In theory, yes. Would this end up being the irony of ironies? No, not really.

by My Life Through A Lens, for Unsplash - central banks
by My Life Through A Lens, for Unsplash

Central banks would not so much be interested in bitcoin as in its underlying technology of the blockchain. More efficient settlement, increased transparency, less economic vulnerability and a greater control over the money supply would have a significant impact on the Bank’s power and usefulness. It could be positive, or it could be negative. We could see a consolidation of central banks’ influence. Or, we could see them blockchained out of existence.

One of central banks’ main functions is to act as a clearing house for interbank trades. A vast amount of money is electronically transferred between banks at the end of each business day, to make sure that the net positions reflect that day’s financial activity. The central banks coordinate and settle this, using a variety of transfer platforms. It’s efficient. But it could be more so, especially if the need for a central clearing house was eliminated. What if the network of commercial banks and other financial institutions could settle directly on the blockchain? The central banks’ obligations could be reduced to that of regulation and monetary policy.

Another main function of central banks is that of issuing the currency. What if, instead of fiat currency, they issued a blockchain-based digital currency? (Which would, technically, also be fiat in that it is backed not by gold or similar, but by faith in the central bank.) That way we could all hold money directly issued by the central bank. Right now the only way to do that is with cash. If we could all effectively “open an account” with the central bank, there wouldn’t be much point in also having commercial bank deposits. Apart from the additional unnecessary costs, commercial banks are not as secure. They do not hold enough liquid assets to offset the client deposits, which leaves clients at the (remote, but still) risk of not being able to take their money out when they want to. With the central bank, that’s not a problem.

But with no retail deposits, commercial banks couldn’t lend as much as they do. Now, they take their retail deposits and lend them out to other individuals and business, thus making money more efficient and giving the economy a boost (not to mention making a profit in the process). This has the added effect of increasing the money supply, by effectively “re-using” money. It’s good for the economy (at least on the surface), but it’s difficult to control. The startling reality is that we don’t actually know what the money supply is at any given time. Central bank deposits at commercial banks can be used to back loans, but the scope is obviously more limited.

So, with commercial deposits replaced by central bank digital currency, lending would dry up (unless we can come up with a way to leverage central bank deposits). But some economists argue that it wouldn’t be a bad thing at all. Either way, the central bank would have a much tighter control on the money supply, and a much greater influence on the economic performance of the country. In theory, anyway – we all know that when it comes to economics, that is rarely the same as reality. The idea is a radical departure from the current economic system that we know. But, coming full circle, that is the point of bitcoin, the reason technologists have been searching for decades for a solution to the persistent problem of decentralized trust. Yet while bitcoin wants to be an alternative to central bank hegemony, the central banks themselves want to get in front of the inevitable change that this new technology will most likely force on the traditional system.

And all of this is not as farfetched as it sounds. Central banks are looking into these ideas, and the past few months have seen a slew of pronouncements from central banks all over the world. Just last week the Bank of England released a report that claims that a central bank-issued digital currency would permanently increase GDP by 3%. In March, Bank of England Deputy Governor Ben Broadbent gave a speech in which he outlined what such a system of central bank digital currency and blockchain settlements could look like. In January of this year the Bank announced that it was looking into the possibility of using the blockchain for the UK interbank settlement system. Last September the Bank of England’s top economist, Andrew Haldane, proposed the idea of issuing a state-backed cryptocurrency while simultaneously applying a negative interest rate on paper currency, or even banning paper currency outright.

Also in March of this year, researchers from the University College of London (not affiliated with the Bank of England) proposed the RSCoin framework for cryptocurrencies issued by central banks. This would allow the central banks to centralize the money supply, allow direct access to payments, and give an exact figure for the money supply at any given time. The cryptocurrencies would run on nodes validated by authorized “mintettes” (I think they’re being serious, I’m not sure).

Just last month it emerged at a conference of 90 central banks from around the world, hosted by the World Bank, the IMF and the Federal Reserve, that several of them have been investigating the blockchain for some time. Earlier this year the Dutch central bank revealed the development of an internal digital currency prototype called DNBCoin, for experimental purposes. And the following month the French central bank announced that it has been actively looking into bitcoin, digital currencies and distributed ledgers. Even Russia’s central bank has expressed an interest in the possibility of a central bank-issued digital currency.

A few weeks ago the Bank of Canada revealed that it has been experimenting with how to apply the blockchain to interbank payments. In May, the Deputy Governor of the Bank of Japan urged central bankers around the world to consider the implications of this technology. India’s central bank is investigating how to use the blockchain to reduce the dependence on cash and improve tax collection. China’s central bank is looking into issuing its own digital currency. The central bank of South Korea is researching distributed ledger applications. Barbados, Kazakhstan, the list goes on. And we can expect many more similar announcements in the coming months.

Cryptocurrencies are a reality, and with technological improvements and increased opportunity, they will become a more widely spread mechanism of financial transaction.  Central banks can watch while their power to control the money supply is whittled away by the increased use of money outside their influence. Or, they could try to compete by incorporating cryptocurrencies into their national spheres. This obviously is not a simple proposition, and the ripple effects will need to be seriously considered. And no-one likes the idea of “experimenting” with something as fundamental as national and global economics. But change is inevitable, cryptocurrencies offer significant advantages, and the demands of the market are evolving. Calling for the disruption of the central banks is at this stage irresponsible, especially since we don’t yet have a viable alternative. However, if the central banks start to disrupt themselves, we could gradually move into a new economic order, with potential and promise that reach far beyond lower costs, faster transactions and enhanced transparency.

Goodbye blockchain, hello ledger

We’ve seen how many bitcoin companies have pivoted away from the digital currency to become blockchain companies. Now, here comes the next pivot: the term “blockchain” is being replaced.

With what? With “distributed ledger”. Not nearly as sexy. But much more accurate, and by that I mean “less confusing”.

We have the bitcoin blockchain. In fact, many insist that the bitcoin blockchain is the only blockchain (“There can be only one”). That is open to fierce debate, and I am in the camp of the many-blockchained universe. I know very smart people who insist that without bitcoin (or other cryptocurrency – and many argue that bitcoin is the only cryptocurrency) as an incentive, the blockchain won’t work. That’s true, if you are operating a blockchain in which the participants don’t know each other. You need a financial incentive to keep it “honest” and to prevent identity-based attempts to control the majority.

But I also know very smart people who insist that blockchains can function well in situations that do not require that level of validation work. If you don’t need the same high level of decentralization and permissionless participation (ie., anyone can join), you don’t need the same incentives. These would be private blockchains, in which the range of participants is limited to a sector or field in which everyone knows each other. While you may not trust everyone in the group, you know who they are and can verify their identity. What you need is a way to allow modifications to the database and the chain of information, while keeping the process transparent.

I’m not going to go into the technical side any more than I already have, at least not today – it’s long-winded and convoluted (and actually only interesting to total geeks like me). To appreciate the trend and the hype, it’s only necessary to grasp the difference between public blockchains such as bitcoin, in which everything is open, transparent and decentralized, and private blockchains, in which participation is limited but which still offers significant business process improvements.

Both systems operate on the same principals, but have slightly different mechanisms. Both technically are “blockchains”. Yet they serve different purposes and have different markets, and calling them both blockchains is generating a lot of confusion. And confusion is not good for new systems struggling to grasp a new concept and explain it to its markets. So, we need to find another name for private blockchains. The obvious choice is “distributed ledger”.  Boring, perhaps. But that’s marketing’s problem. And I’m not sure that the financial sector should sound exciting.

I’m obviously not the only one. Big blockchain players are starting to distance themselves from the “blockchain” label. Some are substituting with “distributed ledger”. Others are not using either. This trend is fascinating to watch, and is just getting started. And in the process, it will bring on a greater clarity of purpose and communication, and foster even more innovation in a sector that really needs it.

Let’s take a look at some of the big names in the blockchain space:

blockchain digital asset holdings

Digital Asset Holdings is arguably one of the biggest. Created as a bridge between the digital currency sector and stuffy Wall Street, it boasts an impressive roster of directors from the financial sector, and deep pockets for blockchain startup acquisitions. Even though its mission is to advance blockchain technology, nowhere on its home page does it mention the word “blockchain”. Nor does the word appear on the explanation of the technology, although “distributed ledger” does.  They do refer to blockchains when talking about their recent acquisitions. But their technology apparently is blockchain-free. Now they call it “Business Logic Engines”. While it’s true that they’re not just focussing on distributed ledgers, it is striking that blockchains are so conspicuously absent from the sales text.

“Our platform can commit transactions to private or public distributed ledgers or traditional databases depending on the requirements of the use case.”

R3CEV has been making headlines recently with its initiative to get big banks to experiment with the blockchain technology. While the press still insists on calling it that, R3CEV has no mention of the blockchain on its home page, not until you get down to the list of press articles about them. They do refer to distributed ledgers, but only once.

Abra, a remittance company that uses the blockchain to send money around the world, has no mention of the blockchain on its home page.  Nor on the “How It Works” page.  If you persist, you can find a well-hidden reference to “modern blockchain technology” on the FAQ section when you click on “What is the technology behind Abra?”.

MoneyCircles is a P2P lending system built on the blockchain, that does not mention blockchain on their home page at all.  When you go to “How it works”, you find it:

“We allow people to create and operate their own credit unions on the Blockchain, which provide savings and lending services to their members without all the usual associated costs and restrictions.”

blockchain safeshare

Safeshare Insurance, which provides insurance for the marketplace economy (sometimes mistakenly called the “sharing economy”) over the blockchain, does not mention blockchains or even ledgers anywhere on their website (that I’ve been able to find, anyway).

BuyCo, which uses the blockchain to make it easier for businesses to get together to buy things, doesn’t mention blockchain anywhere on their home page.

The list goes on…

There’s a whole lot more going on here than a simple re-branding. We’re looking at a clarification, and a step back from the hype. The press will continue to label these companies as “blockchain” players for some time, though. It sounds a lot more interesting than “distributed ledger”, and the press needs a bit of hype to get the clicks. Yet the experimentation on both sides of the bitcoin/not-bitcoin blockchain divide, whatever the system is called, will lead to a greater understanding of the potential, the business models and the economic impact. And we all will get a clearer idea of what the future will look like, with blockchains, distributed ledgers, or whatever the next transformation will be called. Not boring at all.


Blockchain and the necessary hype

I was asked this morning if I thought that there was too much hype around the blockchain.

The question, as phrased, is much more complex than it seems. A simple “Yes” or “No” would be completely misleading.

Is there hype? Yes.

Is there too much? No.

And by “no”, I don’t mean that the hype is at just the right amount. By definition, the word “hype” implies “too much”. In other words, I’m not sure that “hype” can be effectively quantified. It’s like saying “I’m a little bit pregnant”. (I’m not, if you were wondering!). You either have hype, or you don’t. From Wikipedia:

“Hype (derived from hyperbole) is promotion, especially promotion consisting of exaggerated claim.”

According to Google Dictionary, hype (verb) means

“To promote or publicize (a product or idea) intensively, often exaggerating its benefits”.

Both definitions, and most of the other ones I found, stress the exaggeration part, without claiming that all hype is inflated. But the implication is there.

So, we don’t have too much hype. However, I am convinced that blockchain technology is not the revolutionary change that the media and even industry experts seem to think. It is a revolutionary change, for sure. And the creative uses emerging across sectors are very, very interesting. But the potential uses are more limited than we are led to believe. And the hurdles in the way of its widespread adoption are much higher.

I’ll happily go into those limitations in more detail in a later post (lots to talk about there). Today I want to explain why I think that the hype, although potentially misplaced, is a good thing. Why we don’t have “too much”.

It’s all about marketing.

Virtually all hyped campaigns promise more than they can deliver. And technological innovation is especially guilty of that. Remember the promise of the paperless office?

To put this into perspective, I thoroughly recommend the paper by Gartner (2011) on hype cycles. You’ll have no difficulty recognizing where the blockchain is. Mass media hype begins? Check. Supplier proliferation? Check. Activity beyond early adopters? Almost.

from "Understanding Gartner's Hype Cycles, 2011" by Jackie Fenn and Mark Raskino
from “Understanding Gartner’s Hype Cycles, 2011” by Jackie Fenn and Mark Raskino

The report goes into much more detail, giving a list of signs that a technology is at the peak (italics = my comments):

  • The trade and business press run frequent stories about the innovation and how early adopters are using it. It’s not exactly correlated, but here’s the number of times “blockchain” has been searched for in Google Trends:

  • A popular name catches on in place of the original, more-academic or specialist engineering terminology; for example, the wireless networking technology called 802.11g became “Wi-Fi.” “Blockchain” is pretty catchy.  
  • Simple, highly exaggerated, nonspecific declarative marketing slogans appear, such as “I have cloud power” and “cloud is the answer.” Uh huh. My favourite so far is “The possibilities for universal disintermediation across all verticals enables [sic] unfathomable, unforeseen opportunities.” I actually find myself saying similar stuff at parties. I don’t get invited to a lot of parties anymore.
  • A surge of suppliers (often 30 or more) offer variations on the innovation. We’re way beyond 30. My preliminary list is up at around 50.
  • Suppliers with products in related markets align their positioning and their marketing with the theme of the innovation. Yes, that’s happened. Non-blockchain technology providers are either pivoting or adding the service.
  • Suppliers can provide one or two references of early adopters. Many early adopters go on to set up their own suppliers.
  • Investors aggressively hunt down a representative supplier for their portfolio. Some early-stage venture capitalists may sell at this point. See the link to “Money keeps pouring into blockchain startups” mentioned above.
  • Toward the end of the peak, one or two early leading suppliers are bought by established companies in expensive, high-profile acquisitions. There has been a ton of M&A activity in the sector. More to come, I imagine. And a list to follow.

So, there is no question that the blockchain world is swimming in hype. Here’s why I don’t think that that’s a bad thing:

One, it’s part of the natural cycle of evolution. Blockchain, as a new technology that has real potential, needs to go through the Gartner cycle. It hasn’t become an industry standard for nothing. The sooner we get through it, the sooner we can put the resulting “trough of disillusionment” behind us and get on with the real work of implementing the efficiencies across sectors.

Two, it’s all about marketing. To get enough industry players interested (and by that I mean all industries), the blockchain needs some powerful marketing. Change is difficult even when it’s obviously needed. The blockchain revolution is not obviously needed. We’ve been getting things done, sending payments, transferring assets and verifying documents just fine for years. When it’s not obviously needed, the resistance to change is very high. In fact, it can probably only be overcome by unrealistic hype. More accurate marketing, along the lines of “this is a new way of structuring distribution that will probably improve efficiency but we don’t really know what the cost or the unintended consequences are going to be and by the way it’s really complicated”, won’t attract the same kind of eager attention that the blockchain needs. The blockchain needs that eager attention because it needs industries in which to test itself. It needs experimentation, exploration and investigation, and without the hype, willing participants will be more difficult to come by.

Now, I’m not advocating reckless exploration. I’m advocating carefully trying things out. R3CEV’s approach to carrying out tests with a consortium of banks seems like a sensible approach, and one that I’m sure (= hoping) many other blockchain service providers will emulate. Would it have managed to convince so many big names to join the experiment if the hype were not at almost peak level? Probably not. But the fact that it did pushes the boundaries of what we know about the possibilities into the realm of practicality, and brings forward eventual implementation. That’s very exciting.

So, yes, there’s hype. And, yes, quite a lot of it is misleading. But it’s a necessary phase for a strong contender for “revolutionary technology of the decade” (no hype there). Without it, we wouldn’t be as far along as we are. And we wouldn’t have the momentum to take us through the next phases and eventually reach practical implementation and successful innovation.

According to the Urban Dictionary, the word “hype” can also mean a lot of other things: a type of drug user, a sarcastic reaction to something that’s not that exciting, and something that’s really cool, fun and noisy. I’m going to go with the last one. Blockchain technology, with all its limitations and upcoming disappointments, is totally hype.

The magic of the blockchain is that it’s not what you think it is

So, it’s intensifying. From dismissing bitcoin to grudgingly admitting that the blockchain might be interesting, to tiptoeing around more in-depth research, banks now seem to be rushing to experiment with or even outright buy the technology. Let’s take a look at why, and why we won’t see much change in how banks work any time soon.

blockchain - by Joanna Kosinska for Unsplash
by Joanna Kosinska for Unsplash

A large part of the banks vs bitcoin debate revolves around the nature of the blockchain. Bitcoin’s blockchain is decentralized (no-one controls it), permissionless (anyone can use it) and public (all transactions are there for anyone to see). Does that sound like something a bank would be interested in? Something that no-one controls and anyone can use? Something that openly publishes transactions? Not any bank that I know of, anyway.

But surely a bank could adapt it for internal use? Yes, but why would they want to do that? The blockchain works more slowly than a database, and is more expensive to run. If what they want is an efficient way to transmit value internally, a database is much more useful.

What if they want the “permanence” of the blockchain record of transactions? What if they need to know that each transaction, once included, is very difficult to modify, increasingly so the farther back in time it goes? The blockchain is more secure than a database, true, since if a historical transaction is modified, every single subsequent transaction block also needs to be modified. But what if the blockchain is controlled by one entity? What’s to stop it from changing whatever it wants? The system is secure because it is public. A private blockchain is not so secure.

So, why are banks looking at it? In part because of the hype. Blockchain talk is almost everywhere, and if others in your sector are looking into it, you don’t want to be left behind.

And there is value in the notion of a private chain. For a single entity, the expense of the blockchain doesn’t make much sense. But for a group working together, the transparency, security and automation could lower costs and increase efficiency. A supply chain could use a blockchain-like system to pass documents from one stage to the next, for example. The participants would be all entities involved in the process, that don’t necessarily trust one another, and that want the transparency and group verification that the blockchain can offer. Or, a group of banks could create a private chain through which they could enact certain transactions, such as the hand-over of loans, or the exchange of securities. Developer R3CEV recently trialled a chain-based transaction with the participation of a consortium of 11 banks. And the blockchain’s use in securities settlement is potentially fraught with legal barriers, but if they can be worked out, the gain in efficiency and liquidity will be huge.

So, as with most hyped-up innovations, the blockchain is unlikely to be the explosively disruptive force that the media makes it out to be. Its use in private situations is limited. The sector is buzzing with activity, though, as very bright minds research and experiment, for small startups and for large institutions. The results will no doubt produce even more innovation and use cases, some of which will surprise us all. The internet today is used in ways the original developers never imagined. But its impact is unquestionable. We could well see the blockchain acquire the same status: part builder, part destroyer and part transformative magician.

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.