At the risk of sounding like I have an ‘unconscious bias’ against disruptive payments tech such as Bitcoin/Blockchain/Distributed Ledger, I have to say, at this stage I don’t believe that these technologies are ready for banking prime time – yet.

So why would I even say this anyway? Why am I interested enough to even write this?

Because I believe that the blockchain and distributed ledger tech have significant and substantial promise, but I think more work needs to be done on making the underlying technology ‘industrial strength’ – especially for regulated financial services.

“Come on Leigh – go back to your 16th century double entry book ledger you old relic” – I can hear them say.  And yes, I’m a banker of nearly 30 years – but my attitude has always been ‘why not?’ as opposed to ‘why?  I’m a prolific tech early adopter and constantly thinking of ways to improve the client experience especially in corporate payments.

I’m also a little tired of the hype created by the marketing engines of certain fintech companies looking for a large reputable financial service organisation to grab the technology, run with it and blatantly disregard the impacts of the deficiencies in the ‘current’ iteration of the technology. The hype just doesn’t help. It breeds conversation such as:

CEO: “We need a distributed ledger”

CIO: “Why?” ….

CEO: “because everyone else is talking about it”

CIO: “what will we use it for?”

CEO “that’s your problem”.

I almost feel like that we are searching for the problem (in other words a “good use case”) that these solutions have been created for. It so frustrating. I mustn’t be the only one thinking this however, have a look at this tweet.

Every day I read something that indicates the ‘promise’. Maybe that’s the frustrating part. Its like the search for extra terrestrial intelligence. We know its got to be out there somewhere but we just can’t find it yet – or the challenge of exceeding the speed of light – we stand back and marvel at concepts like “warp” from Star Trek and wonder how we will ever get to travel beyond that barrier. We have a stab at what the problem is because we already know what the solution might be.

What is Bank Grade anyway?

How about this for a definition?

Bank Grade payments systems are compliant, they address real challenges, they have clear ROI, and they are scalable.

My current analysis of the ‘current’ technologies to this point shows that they fall short on some or all of the basic requirements.

I don’t intend on giving readers an understanding of what Crypto Currency, Blockchain or Distributed ledgers are. If you are here, then its assumed that you have some knowledge of it, and are at the very least interested.

Lets run the test:

Compliant?

I fear not. Transactions are anonymous for the most part (although there is of course a hash based identifier). If you can link the identifier to an owner then they aren’t anonymous anymore. But the system doesn’t know who you are and because of that they are a regulatory nightmare. With ‘unpermissioned’ blockchains (such as Bitcoin) Entry and Exit points aren’t regulated and so it is virtually impossible to complete any type of sanctions or AML type checking. Recently, for example, the Department of Financial Services in New York introduced BitLicense to try and regulate these entry and exit points. The effect of this however was that most Bitcoin exchanges left New York and set up business in a less regulated environment.

Interestingly the kerfuffle was the community wanting to preserve the ‘anonymous’ nature of the network. Sounds very bank like to me.

With Ripple – If you download the ledger you can see each and every transaction. You can see who the counterparties are, who they trust, what their credit lines are, pretty much everything. Meaning that privacy goes out the door. Do you care? Do you want everyone to see your bank balance and each transaction you’ve done? Maybe that’s not a problem for you, but banks are built on keeping your financial data private. If you know a counterparties ‘account number/hash’ then you can track everything.

Forked Ledgers also present a problem. In banking you simply can’t have two or more versions of the truth. But inside the blockchain you can …. until they resolve themselves … and when that happens you can both win and lose. Banks need one version of the truth at all times – customers expect their balance to be their balance – not a ‘version’ of their balance. A recent fork occurred in Bitcoin that wasn’t resolved for some time – if you read that article words like ‘ your bitcoins are safe if <condition> x, y z, are met’. How would you feel if your bank balance was referred to as ‘safe’ depending on certain items? Not very safe perhaps.

One final point – control. Who regulates this? Who do you go to when something goes wrong? Who is the ‘central body’ that arbitrates? The answer – for Bitcoin at least – is ‘no one’. Having said that, it is the computers that arbitrate – they decide who wins and loses. They do the math. So who owns ‘most’ of the computers – at the present time this is the domain of the Bitcoin Miners. Miners solve the cryptographic problems that validation of the blockchain require, and in exchange for solving the problems they get paid  – in bitcoins. Two thirds of mining capacity is owned by 6 mining pools, and the top 4 pools are based in mainland China – not owned by Government but by private individuals/corporations. In the network then, whomever owns greater than 51% of the mining resource controls the network. For everyone.

So, transactions are anonymous; they are unregulated; they are not private; they are not ‘safe’ in traditional terms; can be controlled if someone owns more than 51% of the network; and you can’t complain to anyone if the system doesn’t work or you lose your money.

If that was a catchline for your bank, would you put your money there?

Address Real Challenges?

The main challenge that the distributed ledger industry favourite Ripple state they address is being able to ‘speed up’ cross border payments. Why? From what I can gather because the transactions flowing can be agreed in real time including FX rate conversion, intra party accounting is completed by way of using the distributed ledger and each party uses the protocol to agree on these things regardless of the time of day.

But does that mean that you actually get your cash faster?

Now that depends on whether the receiving bank has a way of interacting with the ledger in order to deposit the funds into your account real time (taking into consideration the relative sanctions and anti money laundering filtering that Banks are obligated to complete on any incoming or outgoing transfers). For larger transfers, or where there is high volume the bank also has to complete other hygiene matters such as liquidity management for its own treasury function (which is both good governance and good cash management – but you probably don’t care about that). All you want is your money and this takes time.

But the Ripple system works on IOU’s. In other words, the ‘instruction to transfer’ is still separate from the ‘settlement of the transfer’. Ripple is an ‘instruction to transfer’ system. It doesn’t do settlement – because settlement actually needs the transfer of actual money between counterparties. Instead Ripple issues IOUs between counterparties and they must use those IOUs to complete settlement via the traditional SWIFT network. Ripple is NOT a replacement for banks to use SWIFT because that is the way Banks settle their own balances with each other. There is an exception here  – if Banks hold the actual ‘Ripple’ currency they can just settle in that.

Unless of course each and every Bank ditched SWIFT altogether and all around the world invested their funds into buying Ripples.

Ripple ignore these factors, or at the very least brush them to the side. The ‘last mile’ (in other words actually getting the cash into a consumers hands) is a challenge – for Ripple and also for traditional Banks. Ripple still needs the ‘Bank’ to execute the cash transfer, typically via traditional means.

The blockchain itself can also be used for other real world challenges – for example this is where the concept of ‘smart contracts’ is heard. Each clause is a programmatic instruction, and once signed the clauses can execute automatically – and the ledger can keep track of which clause was executed, when, and for what/to whom. The contract can be for trade or almost anything – it doesn’t just have to be used for Bitcoin (or parts of a coin).

But we have systems of record today that solve these problems – perhaps not as efficiently – but solve nonetheless. This area has significant promise though – I think that with the passage of time the underlying blockchain technology will get better and will be embraced by smart innovators who use the blockchain as a ‘building block’ for interesting application that we may not have even thought of today. In effect the blockchain will be wrapped in IP layers of value added functionality that solve real world problems by leveraging the basic framework of a programmatic decentralized ledger.

Clear ROI

It costs a lot of money to run the Bitcoin network. Bitcoin transaction processing consumes significant resources – a recent study concluded that the combined electricity consumption for all Miners was comparable to the entire energy consumption for the country of Ireland.

As the blockchain becomes longer the computing required increases to a point of diminishing returns thereby making it commercially uneconomical. That’s based on todays tech though – Moore’s law will influence here.

Even with more corporate application such as ripple, as previously detailed you still need the banking infrastructure to complete the last mile. So given current use cases there is a lot of change required (in risk tolerance, acceptance of non traditional records of truth, and removal of traditional reconciliation practices) in order to provide enough ROI to balance it all out. At present there are significant unquantified risks with no clear mitigation strategy or payoff. Bitcoins themselves are subject to extreme currency volatility (good if you’re a betting person), transaction fees are relatively high (average 2%) and variable depending on Spam (called dusting), and the FX conversion from BTC to fiat is relatively high when compared to retail FX margins.

That is not to say that there are no opportunities. The tech just has to mature. Or we have to revise the underlying frameworks to better provide for financial services use cases.

Scalable

Another bummer at present. Bitcoin takes between 10-60 minutes to validate and clear a transaction. Unsuitable when compared to a real time credit card or bank account transaction.

Additionally Bitcoin only currently scales to around 7 transactions per second (by design). That’s not very good compared to what is required from global markets (tens of thousands per second or higher). You see – Size matters. Theoretically the throughput of the system could be much higher, but it requires a larger block size. Work has been done recently to increase the speed, but that requires consensus from the miners .. and they don’t agree. Taking us back to the ‘who controls the network’ issue.

I previously discussed the electricity costs.. which will suffer from the same diminishing returns matter and is ultimately dependent on how efficiently computers can solve the mathematical problems of validating the blocks.

On the ripple side, we need significantly higher participation from traditional banks and financial institutions to provide enough scale in order to start to replace traditional systems of cross border payments, but because of the challenges mentioned previously we just don’t have the scale required.

In Summary

I’m not against the technology. I think it has massive potential … with the right use cases and with solutions to the problems presented. And for those who think I’m just an old school banker that is afraid of the potential or disruptive change – think again. The discussion sort of puts you in a combative position which doesn’t feel right. I am on the same side – I want to use the technology . If I could go to my Boss and say:

“I have a solution for you. It will save in costs, it is super efficient and scalable, will speed up payments and improve customer experience, covers the bases in terms of fraud control, sanctions and AML, and help us improve revenues.”

Do you think I would? Absolutely.

I hope one day soon I can. I just cant right now. Its not bank grade – yet. Its a solution waiting for the right problem, but the solution and perhaps the underlying framework needs more work to be better suited for robust regulated financial services.

Post Publishing Note: Ripple did this past week announce “Interledger” as a possible solution for some deficiencies that I highlight above. I haven’t done a full analysis of the impacts of that innovation, but it does look like they’ve ‘wrapped’  layer of fresh IP around the underlying framework in order to make their use case stronger. Good work Ripple!