Here’s a paradox.
Financial institutions like top banks and stock exchanges are hugely excited about blockchain technology, the databasing protocol that underpins bitcoin.
But as the blockchain hype in mainstream finance has grown, bitcoin itself has faced more and more problems. The decentralized network is facing issues with capacity because of a technical limit on how many transactions the blockchain can process per second.
As all this is going on, 42 investment banks have signed up to a consortium experimenting with blockchain technology, banks like JPMorgan and pouring cash into startups experimenting with the stuff, and Goldman Sachs has declared the technology can change “well, everything”.
So how can they all be so excited if the original blockchain is showing cracks? The answer is because banks are planning to use private replicas of the technology, rather than the original blockchain that underpins bitcoin (or an analogous public blockchain).
Chad Cascarilla, CEO of New York-based blockchain and bitcoin company itBit, told Business Insider: “In a public blockchain, you’re trying to get everyone all over the world to agree to changes at the same time. In a private one, you’re not. You’re really just saying you trust everybody that’s on that network because you’ve all agreed to join it. You don’t have these same computational issues that you do when it’s public.”
If bitcoin’s blockchain is the internet, then the private blockchains are the intranet. Only a limited number of people are given access to it, but you still have the benefit of decentralization — identical records are shared across each organisation and updated simultaneously — and the security of cryptography, which means transactions can’t be amended once signed off on. You can cut cost, gain speed, and get security benefits without the processing power burden.
Cascarilla continues: “Bitcoin is a public database. In order to ration access, you basically have to buy a bitcoin — you’re price rationing access to a database.”
The bitcoin system awards bitcoins to people who crunch through the transactions that are waiting to be verified and added to the blockchain — at which point they are official and cannot be changed.
By using this economic incentive, bitcoin has been able to transform the concept of “trust” in a transaction from something centralised, where a Central Banks or clearing house would verify all transactions, into something decentralized — anyone can come along and verify it and they get a reward for doing so.
“When it’s public, that makes sense, what else are you going to do?” says Cascarilla. “You’ve got to limit access to this thing and as you said, there are real costs to maintaining it. Those are the trade-offs.”
But there’s a problem with the way the system is set up — the more people join the network, the harder it becomes to add transactions to bitcoin blockchain. As a result, more and more computational power is needed (and the rewards get smaller too). On top of this, the system is facing issues with transaction processing because of the sheer volume of them.
In the private blockchains that banks are looking at, that’s not a problem because the incentive for signing off on transactions isn’t a monetary reward, it’s cost saving in the form of reducing middle men and speeding up processing times.
Cascarilla says: “You’re appealing to the enlightened self-interest. Everyone wants to have a similar database to the other. It doesn’t cost you that much to run a database if you permission people to join. In a private distributed database, like a private blockchain, you don’t need to restrict access [in the same way bitcoin’s blockchain does].”
You’re appealing to the enlightened self-interest.
Some in the blockchain space have criticised this private approach. The former head of Barclay’s technology division in Europe, the Middle East, and Africa Anthony Watson told BI he believes the approach is “cynical,” with the banks’ customers unlikely to see any benefits. Watson now runs Uphold, a cloud money platform aiming to bring the benefits of blockchain technology to everyday consumers.
itBit, founded in 2012, runs a bitcoin exchange but has also developed Bankchain, an off-the-shelf blockchain solution for banks and other financial institutions that can be adapted for everything from gold trading to clearing securities.
Cascarilla says his company, one of the first bitcoin companies to be regulated by the New York State Department of Financial Services, is in conversation with multiple banks who are interested in running proof of concepts.
So how is it to replicate bitcoin’s blockchain or build a different type of private blockchain? “About as easy as it is to build any other kind of database, which means it can be very hard or it can be just hard,” says Cascarilla.
“The difficulty is coming up with a way to have consensus between different people on the database, so everyone agrees what’s on it. That’s the real innovation that was created. That’s where the science is still new. Even today, common databases are complex to manage.”
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