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Banks Can Cherry-Pick the Best Bits from Bitcoin: Report

Bitcoin wasn't built for banks. But as cryptocurrency technology evolves, bankers and financial technology startups have begun to consider ways that it could prove useful for financial institutions from speeding up correspondent banking to facilitating remittances.

A provocative new report aims to clarify the future of the financial industry's relationship with Bitcoin and related technology. The upshot: banks are unlikely to embrace Bitcoin and other cryptocurrencies. Distributed ledger technology, on the other hand, has plenty of commercial potential since it can help banks move financial assets faster and at lower cost without requiring them to take on the risks that accompany "permissionless" ledgers.

Banks will remain wary of Bitcoin because its "permissionless ledger" relies on anonymous participants to validate transactions, cryptocurrency researcher Tim Swanson writes in "Consensus as a Service: A brief report on the emergence of permission, distributed ledger systems." This setup means that there is no one to hold accountable in legal disputes over the ownership of assets, should someone tamper with a transaction.

The issue isn't that Bitcoin is bad, according to Swanson, but that it was designed to facilitate online transactions rather than those involving real-world assets like homes and cars.

"No bank's going to want to put a billion dollars of value [on a ledger] if it can be destroyed by anonymous validators," he said in an interview.

By contrast, distributed but "permissioned" ledgers use legal entities to validate transactions, providing banks with official records of asset ownership and legally accountable participants. This approach makes more sense for banks, according to Swanson, since "in the real world of finance, all participants are already authenticated and entities like validators and transmitters require legal identities."

Distributed ledger technology has the potential to help banks send cross-border payments and settle and clear derivatives more efficiently, among other uses, Swanson argues. His report cites eight companies, including Ripple Labs, Eris Industries, Hyperledger and Clearmatics, that offer permissioned distributed ledger systems. (Swanson serves as an adviser to the latter two companies.)

"The idea with the distributed ledger system is to say, 'how can we take the useful parts of Bitcoin or at least the ledger idea and integrate it with businesses that have legal reputations?'" said Swanson, who is known for tweaking the noses of Bitcoiners at conferences and on social media.

He is not a complete skeptic, however, given that he works in business development for the digital currency exchange Melotic, based in Hong Kong. But Swanson's conclusions are guaranteed to irk Bitcoin's early adopters and most passionate supporters, who often argue that its breakthrough technology is inseparable from the digital tokens used to reward participants for securing the system.

From banks' perspective, distributed ledgers like the Ripple system have a number of advantages over cryptocurrencies like Bitcoin, according to Houman Shadab, a professor at New York Law School whose research frequently focuses on these technologies.

"Distributed ledgers, at least for now, are more attractive because of the control they afford over the system," he said. "They're not subject to the vagaries of price volatility of the underlying currencies. And also they have a more secure, distributed authentication process that doesn't rely on the incentives of miners who authenticate transactions based on the value of the currency."

Given these differences, the report suggests that the fates of cryptocurrencies and distributed ledger systems may be set to diverge, with each existing "independently, not necessarily interdependently, of one another."

At least one player already established in the distributed ledger space agrees with that assessment.

"The financial industry isn't interested in alternative money and digital currencies," said Robert Sams, founder and chief executive of Clearmatics, which is developing a platform for clearing and settling over-the-counter derivatives. "It's interested in the distributed ledger."

Such technology is innately compatible with the way that financial institutions conduct transactions today, he said.

"We live in a world of dematerialized assets and ownership as electronic book entries," Sams continued. Transactions involving these assets are "held together by layers of accounting systems that are robust but not transparent, slow and expensive."

Sams' company sees particular opportunity in using the technology sprung from cryptocurrencies to overhaul securities settlements as well as the foreign exchange markets and OTC derivatives markets.

"Distributed ledgers could replace the entire technological back end of dematerialized securities in real time, without the need for reconciliations and lots of financial controls," he said. "That's what financial institutions find interesting."

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@celticwarrior72 - You may not be aware, but Ripple is a centralized company, and not a blockchain. They solicited money from investors by trumpeting their blockchain-ness, but offer nothing even close to a Blockchain. While it's true that they are not susceptible to a 51% attack, this is only because they are in fact susceptible to a 1-attack. Probably there's nothing wrong with a system in which one person can disrupt the network. We use such networks all the time, ACH works very well and so does SWIFT. Ripple has far more to do with these institutions, than it does with a Blockchain.
Posted by derosetech | Tuesday, April 07 2015 at 10:55PM ET
I would argue that the world is moving away from centralized (permissioned) institutions. Simply look at other areas of decentralization, Uber, AirBnB, 3D printing, drone delivery services, etc.. All great services that are being hindered by being forced to ask for permission from antiquated institutions. The world is moving too fast now and people are getting tired of asking for permission to interact with one another.

It will be another 5-10 years before banks roll out their frankenstein ledgers and during that time Bitcoin will keep growing. Beyond that, poor management, selective policy enforcement, and arbitrary rules of these frankenstein ledgers will simply drive users to use permissionless ledgers where they dont have to tiptoe around trusted institutions.

Public opinion of banks and governments has been falling dramatically in the 21st century and people are looking for alternatives.

This trend that is emerging rapidly now, especially in silicon valley. Humanity is evolving and we are realizing that its far more efficient to engage on open permissionless platforms rather than on the terms of centralized institutions.

This is the continuation of a paradigm shift, it started with the Internet and it ends in a completely unknown realm.
Posted by Bit Consultants | Tuesday, April 07 2015 at 7:53PM ET
Ripple Labs has been making the same argument for the past two years. Bitcoin's anonymous miner and 51% problems have been its achilles heel since inception. There has never been a situation in which a financial institution will entrust a significant amount of value to the blockchain. No way. No how. Authenticated (permissioned) validation is the way to go. It's been obvious to many people for quite a while.
Posted by celticwarrior72 | Tuesday, April 07 2015 at 5:53PM ET
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