As the world follows the future of Blockchain with expectation, Prof. Markos Zachariadis from Warwick Business School argues why we might be in for a rough ride.
By CoBS Editor Tanvi Rakesh, adapted from ‘Five hurdles blockchain faces to revolutionise banking’ by Markos Zachariadis
Blockchain weighs heavy on the shoulders of investors for all the expectation that has been set upon it. Touted as the next step in the Internet, blockchain has been referred to as a revolutionary technology which many experts claim will “do to the financial system what the Internet did to media”. The Economist goes so far as to refer to blockchain as the ‘trust machine.’
Is blockchain ready to don the crown of expectation that has been set upon it? Prof. Zachariadis of Warwick Business School argues that despite experimenting that began in 2015, four years later it still seems remote that blockchain will rid the world of banks as intermediaries in payment systems. He points out several challenges that the technology must overcome if it is to be accepted as part of the financial system.
The nuts and bolts behind blockchain
Blockchain is defined by a tamper-proof system of distributed ledgers that does away with intermediaries on the internet. The technology is undoubtedly complex, with many versions in existence, but all distributed ledgers share a basic premise which shapes their day-to-day operation and governance: they offer a decentralised infrastructure to maintain a ‘single version of truth’, recording all changes made on the blockchain database since its formation. This implies that there could be no need for a central authority as all blocks across the network share the same full copy of the database – the shared ledger – and thus no administrator needs to hold a ‘master version’. The blockchain allows the creation of trust without relying on intermediaries for it.
Experts and blockchain investors predict the technology will do away with the need for banks to act as intermediaries, so that when a person purchases groceries online it would immediately be recorded on the distributed ledger, rather than taking a couple of days to register in their account. This is unlike the system used by banks where they contact each other based on a system invented in the 1970s: the blockchain takes care of it instantly.
Who’s making the rules?
Blockchain functions as an ecosystem of communities, with formal procedures to initiate and implement change in the technology being non-existent. Decisions regarding updates and improvements take place through huge debates in the community, with groups forming and arguing over issues such as the length of a block, the number of transactions it should hold and how quickly they should be chained. As such, there is often no solution to these debates, with no way to organise these communities and make decisions. This has, on numerous occasions, resulted in a split, a famous example being that of bitcoin founder Vitalik Buterin’s creation in 2016 of a new form of ether following the ‘theft’ of some $60 million’s worth in equivalent and traditionalists’ determination to carry on using the old ether, now known as ethereum classic.
Democracies rely on predefined processes to mediate, resolve debates and gain consensus which prevents them from getting stuck – as such, blockchain’s lack of a central authority can prove to be a hindrance. Prof. Zachariadis raises the question of who should really be in charge of such a dynamic system, for unlike Apple – which releases operating systems upgrades, as and when it deems it necessary – blockchain lacks a decision-maker to decide how the technology functions and if it needs updating. Another dimension is the enforcement and adjudication of rules. If they do exist, then who should be responsible for administering them? An obvious solution would be to introduce a voting mechanism to make decisions, as in the case of most democratic systems, but the introduction of a voting system would weaken the very principle of the blockchain, leaving it vulnerable to lobbyists or to active contributors wishing to seize control.
Who’s taking the big decisions?
In order for blockchain to become the global payment norm, it must be able to process enough transactions to service its user’s needs. Despite blockchain’s popularity, it still functions on a very small scale compared to other forms of electronic payments. Currently Bitcoin’s blockchain can sustain 2,000 transactions every 10 minutes – whereas Visa handles more than 65,000 transaction messages every second.
A burning debate over appropriate block size continues to smolder within blockchain communities. Proponents of a smaller block size argue that blocks be kept small to encourage more participants to mine crypto-currencies, but critics insist on the need to scale-up in order to increase transactional capacity and increase its user base – this could mean fewer specialist developers mining larger blocks. On the other hand, backers of a smaller block maintain that increasing block size would increase participation costs, thus reducing decentralisation.
The inability to resolve what became known as the ‘block size debate’ has resulted in multiple splits since the launch of Bitcoin in 2009. As such, the debate on scale needs to be resolved for blockchain to grow big enough to become part of the world’s financial plumbing.
Who sets the standards?
Currently, Bitcoin owners cannot take their cryptocurrency to different platforms such as Ripple or Litecoin and exchange them. Interoperability is the big elephant in the cryptocurrency room. This is because blockchain transactions use proprietary formats for the messaging to exchange tokens, with no agreed universal layout of the transaction information among the various blockchains. In a financial payment, a block will hold the person or company’s name, account information, payment, location address and other relevant information, but different cryptocurrencies employ different systems, thus making convertibility a challenge.
The need to create standards for the information and how it is systematically laid out hangs in the air. To resolve this, Prof. Zachariadis proposes that a body – such as the Internet Engineering Task Force (IETF) for the internet – take the lead and establish a general consensus regarding standards.
Who bears liability?
When the traditional banking system encounters a problem, clients turn to the bank. And if the banks fail, the economy turns to the government. However, when a blockchain malfunctions, no one is liable. Prof. Zachariadis insists liability will need to be cleared up before the public can begin trusting blockchains in case of failure. To resolve this, he calls for the need for regulation in the space of cryptocurrencies and blockchains in general.
Who has access?
Transactions on the blockchain are visible to all users – users are pseudo-anonymous, meaning that they are not obliged to identify themselves in any way, but can still be traced through their alphanumeric address – which facilitates the auditing and tracing of transactions. This implies that other users can see the amount of crypto currency going from one address to another, but are unable to link a name to the address. But as coins are spread across the universe of blockchain and buying one gives the user a key to unlock their movement, users are indeed able to track who ‘owns’ the crypto currency.
Prof. Zachariadis argues that although blockchain’s transparency is its strength, eventually the lack of a digital identity and identification framework will be problematic for many users and investors as it is a fundamental premise on which the financial system resides.
Blockchain’s strengths become our downfall?
While experiments with the technology continue, blockchain currently looks more like a complement to the system in place rather than the internet’s native currency. Projects such as Libra – a permissioned blockchain digital currency proposed by Facebook which has received mixed responses – seek to tackle some of the challenges Prof. Zachariadis has raised. Despite these efforts, a world dominated by blockchain-based cryptocurrency is afar.
While blockchain revels in the absence of a central authority and celebrates the decentralisation that the system brings, the void left by the lack of a governing body leaves a gaping hole. Can blockchain technology sufficiently fill this without requiring intervention? The success of blockchain hangs in the balance as financial institutions and communities scramble to find the answers in the race to crown it as a ‘foundation technology’.
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