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.


Xapo ups its bitcoin storage security by stashing a key in space

Bitcoin has had a messy start to 2015 when you consider the breach of the Bitstamp exchange alongside plummeting prices and miners going dark. But for Xapo CEO Wences Casares, it’s just growing pains as the infant cryptocurrency tries to build a more solid infrastructure and go mainstream. To do its part, bitcoin storage and wallet company Xapo plans to announce Thursday several new security features to further strengthen its vaults and make that storage free to use.

“When we talk to customers who have heard of bitcoin but are not yet using bitcoin or owning bitcoin, they always mention security as one of main hurdles of using bitcoin and its understandable,” Casares said. “That’s why we’ve from the beginning focused on security.”

Previously, Xapo customers paid a 0.12% annual fee to hold bitcoins in what the company calls its vaults (those customers will now be refunded). The five vault locations are underground in mountains, Casares said, including a main vault in Switzerland. Xapo uses “deep-cold” storage, meaning that account keys are created and kept in offline servers that has never touched a network.

Typically, “hot wallets” in bitcoin are on the network and therefore more susceptible to hacking and loss. For example, Bitstamp lost 18,000 bitcoin from its hot wallet in last week’s breach while the rest of the coins held in cold storage were spared. Compared to last year’s MtGox debacle in which 850,000 coins were lost from the exchange, bitcoin security has arguably made some strides forward.

As part of that push, Xapo is adding multiple-signature validation to its vaults. That means if someone wants to withdraw bitcoins, it must be signed off on by three of the five vaults worldwide. So if someone did break into one vault, no account could be compromised without having access to at least another two of locations, Casares said.

“Each one of these keys we keep in different private offline servers, in metal vaults, that are in deep underground bunkers,” Casares said. “If someone wanted your bitcoin, they would have to raid simultaneously into different vaults on different continents.”

And if hiding bitcoins in a mountain didn’t seem extreme enough, Xapo is also going to stash them in space. The startup is partnering with Satellogic, a satellite company where Casares serves as an adviser, to move a “digital fingerprint” of Xapo’s security system into space. If someone was to hack into Xapo’s software, the fingerprint of the system in theory wouldn’t match, denying access (unless you also physically change it in the satellite itself).

So-called “multi-sig” technology is pretty similar to two-factor authentication, and the idea of having multiple people, or keys, sign off on transactions is finally catching on in the bitcoin community. Bitstamp added it after their most recent breach by partnering with BitGo. Expresscoin, a bitcoin and other alt-currency retailer, also announced today that it is adding mult-sig tech to its exchange, courtesy of Gem.

What remains unclear, however, is how many people are actually storing their bitcoin in Xapo’s vaults. When asked how many users the company had, Casares declined to comment, citing confidentiality like a “Swiss bank.” The company has received criticism last year after touting a Mastercard-linked debit card in April, only to have it not linked to Mastercard at all and only available to overseas customers. Confusion over the card fees also drew the ire of its previous supporters, although the fees remain an important part of Xapo’s revenue stream now that the storage is free.

And amid a price crash, it also remains uncertain how large a market will remain of people needing to store bitcoins, especially as the hype cycle is now championing the miracles of blockchain technology compared to the volatile digital currency. Casares, though, said one doesn’t have to win over the other.

“I am a believer in both,” Casares said. “If you have a perfect public open ledger, one of the first things you’re going to want to use it for is money. That’s why bitcoin is first.”