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Should Banks Be So Fired Up About Bitcoin or The Blockchain?

In my book Shift, I said open source movements like Bitcoin are the wildcards that keep the economy moving in strange and unpredictable directions. It is disruption as a way of life. Built on blockchain technology, surrounded by an immediately scaled, global community, Bitcoin feels like a very Napsterish moment, shifting the way people think about distribution (in this case the distribution of value) without necessarily having all the credentials to be the fundamental building block of change (see a well argued, opposite viewpoint here).

Yet many banks are bullish about the blockchain (way before any proof of concept has given them good reason). Why?

The first reason is that many banks have serious legacy technology problems that get multiplied when they contemplate interacting with other bank legacy problems. Blockchain seems like a very simple ledger, one you write to once, gain instant agreement (through cryptographic discovery or some kind of consensus algorithm, in the case of payment and settlement startup Ripple) and then move onto recording the next transaction.

One shared record is immutable and cuts out any process errors that arise as records are transferred between different systems or curator costs that come with having a custodian be the record keeper, as happens now.

The second reason is that banks have now separated out their innovation functions from their execution funtions. it is possible, if not too easy, for innovation departments or technologists that have been granted Google time to rethink processes, to play with the blockchain and be seduced by its apparent simplicity

Business Insider quotes Aditya Menon, MD of global digital strategy at Citigroup:

On the blockchain, there are two parts that interest us. One is, today we are one of the largest movers of money -up to $1 trillion or more on a daily basis – because we’re the only bank that actually operates in 100 countries. So, there is obviously an opportunity around our own general ledgers.

If you are head of global digital strategy then you have to be looking at blockchain but that doesn’t make it the right technology for banking functions. Citi is taking a slightly bolder step by experimenting with its own currency CitiCoin (BNY Mellon has dome something similar internally by using a digital currency to reward staff).

While the idea of moving so much money around appears highly scaled, think of the number of API calls per day on the servers of companies like China’s Alibaba and TenCent. Hundreds of millions of users (350 million active users for Alibaba; annual orders, 12.7 billion, deliveries 4.3 billion) in the world’s largest Intranet (China), these systems run on best of breed web technology managed through a continuous process of code reduction and system improvement built into the working practices of the programming community.

Scale, in other words, doesn’t necessitate the blockchain – probably the opposite as blockchain is difficut to scale.

Banks though are keen on what they call the distributed ledger aspect of blockchain, one where consensus is created by the ledger being openly available to all participants. However, Bitcoin is a replicated ledger rather than a distributed one – each instance, each transaction, the whole blockchain is continuously replicated across the servers of all participants. Replication negates the value of a distributed computing system.

And in a sense bank-led digital currencies bring the banks into conflict with the startup community and possibly regulators – Ripple has its own currency XRP, which operates as a kind of token for money flowing through the Ripple system. Competition is no bad thing, in principle, but bear in mind the Fed and the Bank of England have also talked about creating digital currencies (and they are not the only central banks to do so) – much more of this and we will need a derivatives structure to de-risk the different valuations between fiat-backed digital currencies, a development that would be just self-defeating.

If you then ask why are the bank so interested the answers are:

  • They have to be – they are struggling to find radical cost reduction and the blockchain could (but won’t) be it.
  • They have embraced innovation and it would be tough to turn a blind eye to the possibility of blockchain, though in reality it would be more courageous to do so.
  • It provides built-in thought leadership, a feature startups are only to happy to cultivate – we have yet to see  a senior banker though create a real vision for the future of finance; blockchain provides that thought leadership, even though most banks are already advocates at some level, so the search for leadership increases the sense of a race.

I think the lessons from the blockchain gold rush are:

  • Ok, it pays to look at options but you need to be looking at viability at low cost (a fact that some banks get), what one might call minimum viable optionality. Blockchain should be put in perspective quickly, by a disciplined process of low-cost viability testing.
  • Look to how web pioneers are handling much larger record systems than banks do. The answer lies in highly granular innovation processes where developers fight for great fixes and are smart enough to take the latest ideas and push them to new limits.
  • And finally don’t be too preoccupied with your own needs – what do bank customers’ want? That should be the guiding principle of the minimum viable option.