Saturday, September 12, 2015

Financial Technology that Makes the World Better - Is the Blockchain an Option? Part II

This is the continuation of the article on Bitcoin and blockchain technology from Part I. The same format from Part I applies here in Part II in that the comments from our expert are shown in bold italics. Comments in regular type are mine. This article will stay on the blog until Monday to give readers plenty of time to read both parts. Also, links to this article will be permanently posted on a new page on the hand side of the blog for easy access over time.

3) Is the technology (Bitcoin/blockchain) safe to use?

In this case, safety would mean that people's money could be safely held and available to use when needed. Right now, there are still a lot of questions as to how well protected Bitcoin accounts really are. Also, there is no entity to guarantee against loss or theft if it does happen. 

With domestic transfers free or already becoming free and real time in most OECD countries, and cross border payments rapidly following suit - it seems that trading/bartering in and out of the Block-chain is an unnecessary expense of additional intermediaries (which can deduct 5-20% of the total value of a payment in fees). It is openly available for review, that sending money to Mexico and back, from USD to Pesos, via Bitcoin, is more expensive by a considerable margin, than using Western Union. If protecting your capital from fees counts as security, bitcoin isn't there yet.

One of Bitcoin's key security related strengths is the large number of computers involved in 'watching' the safety deposit boxes. However, it is also claimed openly, that one of the other advantages of Bitcoin is the anonymity of the owners of bitcoin addresses (the "safety deposit boxes"). This has lead to the theft of the ownership codes of these safety deposit boxes with virtually no protection available to the legitimate owner. If you forget, or delete, or digitally lose your 'bitcoin address" - you are flat out of luck. There is no contact center that can put it right and no proof that the value you have lost was ever really yours. Those funds can never be retrieved. They are just like cash, but digital and with no serial numbers. It goes as far as being difficult to prove (in court) that you didn't intentionally disseminate your ownership credentials.This means even an enormous bitcoin theft may not even be provable as fraud. 

By contrast, if your bank account details are stolen or your credit card details are revealed by a cyber attack on your favorite store, it is usually just secondary data that is compromised. Something like a card number, or your name and address - not the actual value of money. From there the banking system swings into action and protects you. This is different with Bitcoin. Once your bitcoin value is removed, it has become anonymous.

Obviously this is a bigger problem if you have more than your pizza money stored on that system. And what if you want to have your retirement account or your savings or your salary paid into the block-chain as proposed by the earliest adopters seeking to encourage universal uptake? It certainly doesn't seem ready for the average man in the street, riddled with private and social shortcomings that have yet to be solved by a universal, population verified ledger.

This raises another point - visibility. Anyone can see your anonymous wallet. They may not know it's you initially, but they will soon be able to identify you in the same way an analysis of your internet activity can narrow down your interests, or advertising value, or zip-code. You receive a payment from a bitcoin wallet that is known to have been your employers? You pay taxes to a known bitcoin wallet of your town council? You shop at the same store that was identified as your local Target or Wall-Mart using bitcoin? Data Privacy doesn't apply to you here. 

This is already becoming a problem for many holders of blockchain addresses containing large quantities of bitcoin. Bitcoin owners have reverted to owning many addresses holding only a few bitcoin each (see this list of addresses all with the same date stamp for "last transaction"). This is a practice that, given the risk of losing your wallet address, is "irrevocable/non-recoverable". 

Most of us would need to revert to some form of externally developed technology (or an even an app) to manage these multiple, more discrete, addresses. But without the checks and balances of the formal system, (including Regulation E) the reality is that it's not going to be the blockchain that exposes your large number of wallets to the prying eyes of criminals. It's going to be your computer, your app, or your 'bitcoin aggregator' that's going to get penetrated. When that happens, they like you also have no recourse

So once again, it all comes down to the same problem. Why add in the additional step of the blockchain when banks already do the same job for high, but lower overheads and costs that are already dropping quickly all over the world? Bitcoin doesn't offer price stability (a store of value), or particularly comforting levels of overall security to non-technical people, or a rate of return, or even widespread adoption. 

This is not an insignificant cluster of roadblocks. As a result, the media and those involved do appear to have dialed down the formerly universal rhetoric that Bitcoin was the purpose of the blockchain (and that it might be a near-term replacement for the US dollar). This lexicon has all but vanished. Interestingly,  the blockchain is reliant on the value of the bitcoin to continue to pay the cost of processing its transactions. No bitcoin - no Block-chain? We'll watch this space.


4) Does the technology serve only a relatively small niche of the population or does it improve the lives of a significant number of people, including those who need it most?

So far Bitcoin (and all forms of blockchain technology) are clearly a niche product serving a relatively small core of adopters. There are many problems and issues it will have to overcome to achieve the status of a breakthrough technology. Bitcoin and blockchain technology appeals to some because they see it as a way to bypass the existing banking system. While this will appeal to a niche of people, it is not likely to sway a significant number of people to adopt it. Especially those who need a low cost payment system the most (like the unbanked and those who use remittances).

Beyond the niche markets, bitcoin is also missing significant components and tools, that are required to manage financial markets and stability across economies, or within regions. Some of these missing components are the drawing cards to early adopters, but will ultimately impact it's suitability as a form of transfer or store of value. 

Even the most modern turn of direction for the use of the blockchain (which focuses on the "private chain" to overcome inefficiencies and where a relatively restricted number of trusted computers can participate in vastly less resource intensive validation process) still sounds a lot like an older, more simple, database technology. It seems similar to the standard option that has been running the world's payment systems for decades (not truly cutting edge technology that will help the average person on a broad scale).

All that aside, if we were to get another major financial crisis that shook the confidence of the general public in the current banking system, it might increase the number of people interested in Bitcoin (and other ways to use blockchain technology). But even then, it is just as likely (or even more likely in my view) that people would look to more traditional forms of currency (cash or precious metals) rather than Bitcoin. The problem Bitcoin will have is that under a crisis situation most people will likely just see Bitcoin as some kind of unknown black hole where their money could disappear and never re appear. The overwhelming majority of people would feel like cash currency or something like gold or silver coins in their hand would be much a better option under crisis conditions in my view.

Assuming we are not under crisis conditions, most people (including those who need an easy, secure, and low cost payments system) will not want to fool with something like bitcoin that they really don't understand very well. They want the most convenient and lowest cost payments system available. Those who need this the most (people who send remittances back home to family and friends) will especially prefer the least complicated and lowest cost system available.

As a genuine challenger to the existing alternatives, despite the enormous capital, intellect, hype and enthusiasm invested in it to date, bitcoin still doesn't appear to show signs of having a clear superiority over the normal ways people transact business today. They prefer using cash, cards, or alternative systems like Dwolla or Paypal. They even prefer the speed or cost of cross border payments at many banks. This is especially true in countries where checks have been outdated for a generation or skipped entirely.

So, while the complexity of bitcoin, and the costs and complexity of the blockchain network keep rising, we'll keep a close eye on the progress of the formal banking payments sector too. We will watch with interest as their systems evolve and converge with the latest trends of the blockchain. Will the blockchain be a sort of "back to the future" in payments technology with bitcoin initiating banks to survive? Time will tell.

Added note of interest: The expert who wrote most of this article sent me this article link in an email along with the following comments (this is an expanded version of his comments he sent me in a new email update on 9-13-15):

"In 2012 - it was apparent (to me) that the blockchain was technically limited.. fundamentally designed in a way that made it impossible to scale beyond a few (hundred thousand) users, or ever grow to a national scale system.. And it turns out this was well founded. The transactions are severely limited - and the community now agrees. It took 3 years!

The alarming outcome of this - is not the speed or lack of expertise - it is that they found a fix... Which means bitcoin has none of the "permanent security features" they all claim. The strength of bitcoin was always that it was cast in stone. However, a single coder has been able to deploy a core change to the code - which slows transactions, but boosts capacity. This seems okay - until you consider that this breaches the fundamental principle of the  protocol's security claim.

Simply "convincing half of the miners to adopt BitcoinXT" - as has been proposed - is also the same in nature as deciding to seek a private consensus amongst miners (even just one) to one day "delete all transactions from wallets/addresses/accounts that have ever been affiliated with X."        

(added note: X could be (impacted by) any new rule, including setting all wallet values to $0.00 for any wallet that has, e.g., traded with starbucks, paid taxes, or received income from the US millitary). XT is the proposed new version of the BlockChain 'rulebook' ("BIP") to deal with the size limitations of the current blockchain).

For a more in depth look at the Gavin Andresen article that confirms the concerns our expert mentions in the email above he identified in 2012, go here.

No comments:

Post a Comment