7 “Deadly” Reasons Why Bankers Misunderstand Blockchain
Many leading bankers and financial institutions publish opinion articles that reveal where many of them slip up when it comes to understanding cryptocurrency. One recent example was written by the Research Manager of the Bank of England’s Research Hub, John Lewis, on the bank’s blog titled “The Seven Deadly Paradoxes of Cryptocurrency.”
In the article, Lewis outlined what he believed to be seven “paradoxes” or challenges then facing the entire blockchain community and fintech in general. On top of a host of inaccuracies (outlined below), it seems Lewis committed the sin of misusing the definition of the word “paradox.”
Let’s take a closer look at where many in the banking industry appear to run astray when it comes to blockchain.
1. Positions of Bias
The rationale used by bankers like Lewis reveals a disconnect and a clear position of bias. They fail to mention any of the drawbacks and negatives inherent in our present centralized global fiat currency system. Concepts such as the apparent infinite supply of fiat currency, the resultant inflation, the flow-on effects of the removal of the US dollar from the gold standard, and the accepted social convention of fiat are completely missing.
A primary feature of decentralization of currency is its elimination of the need for middlemen (like money managers) who eat away at the overall wealth and value of a portfolio, often with questionable benefits and value. This forms one of the key advantages of decentralization for consumers, institutions, and the greater financial market overall.
Perhaps the threat of being rendered obsolete and discarded onto the scrap heap of history informs the prejudice here. Many appear to write their critiques without demonstrating a knowledgeable understanding of the subject at hand.
2. The Conflation of Bitcoin with Other Cryptocurrencies
Another common mistake is critiquing the entire blockchain industry from under the Bitcoin umbrella—sometimes even swapping the two as if they were interchangeable.
Bitcoin (BTC/XBT) is the original, most popular and well-known cryptocurrency, with the greatest market share and largest market capitalization (currently valued at US$126.5 billion). However, as a first-generation cryptocurrency, it doesn’t have the characteristics and advantages that newer cryptocurrencies and protocols possess.
Over the last few years, Bitcoin’s dominance in the industry has fluctuated wildly from 86% to 32%. Bitcoin no longer commands the 80% to 90% dominance it experienced before the popularity of many of these newer blockchain protocols or altcoins exploded.
Lewis’ “concentration paradox,” which postulates that the concentration of Bitcoin is extraordinarily high, falls into this conflation trap. While some cryptocurrencies like Bitcoin do have a high concentration of ownership (such as Ripple, which is practically centralized), there are alternatives that go to great lengths to spread their ownership into a more equitable distribution.
3. Blockchain’s Growth Potential
Another point many bankers like Lewis mention is that if the emergence of “newer cryptocurrencies” solve Bitcoin’s challenges, this would represent “additional downside news for the value of existing ones.” While this might be the case for competing shares of companies in the same industry, and other instances where the market is both established and saturated, the overall global cryptocurrency market is still in its “early adoption” phase. Most of the world’s population presently doesn't own any cryptocurrency.
This represents an opportunity for huge upside potential with market growth. Increasing the size of the entire pie should theoretically grow each slice of the pie with it. Also, while cryptocurrencies do compete with each other, there are several projects tackling the issue of interoperability between networks.
4. “Private Cryptocurrencies” and Anonymity
Another repetitive mistake is the continual referral to “private cryptocurrencies.” There's nothing all that private about many of the distributed public ledgers which dominate the cryptocurrency market. If anything, they are pseudo-anonymous.
According to a recent white paper by Helene Rosenberg, Director of Cash Management, Global Transaction Banking for Barclays US, it was found that “while Bitcoin has a reputation for anonymity, the entire history of Bitcoin transactions is visible to all users. Therefore, the blockchain technology/ledger, combined with a monitoring tool, actually allows for increased visibility into potential clients’ activity – more so than would traditionally be available for MSBs [Money Service Bureaus].”
For Bitcoin and many other cryptocurrencies, all transactions are recorded and can be viewed on the public ledger. Public addresses and transactions can be searched via online public blockchain explorers such as blockchain.com, which lists all blocks created on both the Bitcoin and Ethereum blockchain.
Several altcoins that focus on privacy as their niche specialty (such as Monero, Zcash, and PIVX) serve as a point of differentiation from those on public ledgers, where the identification of the sender and receiver on their networks isn't visible. The advantages of anonymity include increased security and confidentiality of information between the transactional parties (e.g. an employer and employee).
5. Perceptions of Illegality
Another glaring fault is falling into the trap of consigning to the all-too-common outdated beliefs that cryptocurrencies are primarily a tool exploited by “money launderers, tax evaders, and purveyors of illicit goods.” This is somewhat of a misnomer and another example that demonstrates why bankers and financial analysts possess a misunderstanding of what cryptocurrencies are and how they intend to function.
In a fairly recent statement, Jennifer Fowler, while Deputy Assistant Secretary for the Terrorist Financing and Financial Crimes Office at the U.S. Department of the Treasury, claimed that “although virtual currencies are used for illicit transactions, the volume is small compared to the volume of illicit activity through traditional financial services.” In a nutshell, illegal activities plague all forms of currency, whether they are a newer cryptocurrency format or an established fiat currency.
This issue is expected to be minimized further as more national governments worldwide enact legislation dealing with digital currencies and provide regulations with a set of standards. As a result, this will not only establish confidence with interested investors considering crypto investments, but also a swathe of institutional investors and managed funds.
6. Misunderstanding of Innovation
Many people in finance outside of the blockchain bubble have an inability to keep up with innovations and evolving solutions to many of the problems or “paradoxes” outlined in Lewis' article. These tech issues specifically concern Bitcoin. However, recent developments in Bitcoin’s protocol, as well as the introduction of second-generation blockchain protocols (such as Ethereum) and third-generation protocols even more recently, address many of the outdated issues and concerns raised.
Concerning the “storage paradox,” “digital storage costs,” and the reference to “diseconomies of scale,” a solution has been the development of cold storage hardware wallets that can store a user’s private keys in a safe offline hardware wallet.
To address scalability and the number of transactions per second (covered under Lewis’ “congestion paradox”), Bitcoin and other blockchain protocols have adopted the Lighting Network which is “capable of millions to billions of transactions per second” across a network. Other protocols have tackled this issue with other solutions.
The issue of Bitcoin transaction costs being too high, which was the case back in 2017, has largely diminished due to a range of factors, primarily a lower demand for transactions, the growing adoption of the Segregated Witness scaling feature, and batching—where many transactions are rolled into one.
7. Disregarding Blockchain’s Clear Advantages
There is also a failure by many to recognize the numerous benefits and advantages that blockchain has to offer.
Smart contracts (which render transactions traceable, transparent, and irreversible) and decentralized applications, or DApps, can revolutionize the way commerce and transactions are conducted in a vast array of different fields and industries. These benefits include greater transparency, enhanced security, improved traceability, reduced costs, and an increase in efficiency and speed of transactions.
It is surprising to observe a banker such as Lewis who doesn't seem to understand the basic tenets of supply and demand that determine a commodity or currency’s value. Overall, there are still many bankers and financial institutions that lack an understanding of the advances that cryptocurrency and blockchain tech have made. This is particularly relevant in the failure to recognize recent developments, as well as an inability to grasp some of the concepts underlying the issues raised. Perhaps when more in these groups, as well as the general public, begin to understand just what blockchain is and what it can offer, there might be some hope for greater change and transformation.