Blockchain and trust

I’ve read a few articles over the last year linking blockchain and trust (see footnotes). I find the analogy a good one, but not entirely complete. Blockchain can serve as a technical intermediary between parties looking to execute an agreement (such as the transfer of digital cash). It then creates a record of that agreement, replicated across multiple parties (therein the distributed nature of the ledger). This record should be immutable, which in theory means it is tamper proof (unless you have more computing power at your disposal than the entire network of “miners” who validate your transactions).

Having an automated mechanism to serve as an intermediary or arbiter of an agreement sounds great in principle. If we’re just looking to process a transaction that both parties agree to, it’s ideal. Cut out the middleman. Save money. Get an outcome that is dependable, unbiased and objective. No wonder so much money has flooded into blockchain, or DLT. But what happens when things go wrong?

What Is Trust?

The financial services industry is built on trust. But trust is not measured on a binary scale. It’s not an all-or-nothing concept. It comes in various shades.

At the most basic level, we can trust something to function as we expect. Every time you pay for something electronically (either through a card transaction or bank transfer), you trust that the right amount of money gets taken from your account and is deposited to your chosen payee. Equally, you trust that the money you deposit with your bank is kept safe, made available at your discretion (when you want to pay for something), and will hopefully accrue a bit of interest (albeit microscopic amounts in the current climate).

This kind of mechanical or functional interpretation of trust is all very good. And it is why there is so much interest in blockchain as an intermediary of trust. But there is also a higher form of trust, which I would argue is more important in the financial services industry. This kind of trust is a human construct. It cannot be automated. And that’s because we trust in individuals and institutions to do what is right.

We trust our providers of financial services to exercise their judgment, to protect us from fraud, to look out for our best interests – and generally to behave in an ethical fashion.

Unfortunately, this trust can sometimes be broken. From boiler room stockbrokers to retail mis-selling scandals, there is no end of examples where service providers have chosen their own best interests over their clients’.

But that’s exactly why the financial services industry is regulated so heavily. The very fact that so many scandals come to light is evidence that systems, processes and institutions are in place to redress injustices and restore trust when it is broken.

Can You Truly Automate Trust?

I am by no means a luddite. Nor do I believe in standing in the way of technological progress. But I am sceptical as to how any technical solution can truly automate the trust we place in people and institutions.

One case in point is that of The DAO (Decentralized Autonomous Organization), an investor-directed venture capital fund run on the Ethereum blockchain that was drained of large sums of money shortly after it launched. In spite of siphoning off $50 million of other peoples’ cryptocurrency (rather aptly named “ether”), the “attacker genuinely believed they had done nothing wrong and had simply operated within the rules set by the DAO. The perpetrator even wrote an open letter threatening legal action if, as transpired, the misappropriated currency was returned to investors via a “hard fork.”

Some people in the cryptocurrency community even sided with the “attacker,” as the decision to carry out a hard fork called into question one of the central tenets of the blockchain: the immutability of the ledger. And who is to say they are wrong? Perhaps it’s a question of whether we believe in obeying the letter or spirit of the law. When rules are hard-coded, then it is easy to lose sight of what is right and wrong, and only focus on what is functionally correct.

Personally, I doubt whether any contract – no matter how “smart” – can remain watertight indefinitely. No finite set of rules can be infallible or incorruptible. Vulnerabilities will always emerge – either the technical kind that need to be patched or legal loopholes that need closing off. The laws, rules, contracts and codes that govern our society are always changing. They are always being tested. They are always evolving and adapting to new norms. This process of evolution requires a sense of right and wrong, basic common sense, deductive and philosophical reasoning – all of which would be very difficult to automate. Ultimately, it requires human judgment.

Why I Don’t Trust Bitcoin

Bitcoin is essentially a digital bearer currency, which means it’s the digital equivalent of holding notes and coins.

One of the much heralded “revolutionary” features of Bitcoin (and blockchain) is that it solved the double-spending problem. This problem arises from the fact that digital assets are very easy to copy. So if I had a digital token that represented a unit of currency, I could theoretically give copies of that token to multiple people at the same time. I won’t go into the mechanics of how Bitcoin has solved the problem, but suffice to say that it seems to work.

However, what most Bitcoin and blockchain enthusiasts fail to point out is that the financial industry has also solved the double-spending problem. Much to my chagrin, and as hard as I’ve tried, I’ve never been able to double-spend the same pounds and pence that sit in my bank account. I also use this money to “digitally” pay for things in real-time via my cards or through bank transfers (whereas Bitcoin transactions can take up to an hour to be properly confirmed).

It’s true that I can’t actually keep possession of the cash that my bank safeguards for me, at least not as a digital bearer currency. But why on earth would I want to? The financial system is designed to serve fiduciary responsibilities. And one of the most basic of those is to keep your assets safe. With a bearer currency (or security), those responsibilities are taken on by the bearer of the asset. If I held a one million-pound note, I would feel very uncomfortable walking around with it in my wallet. I would feel very uncomfortable leaving it at home. I would want to deposit it with someone whose job it was to keep it safe.

Even if I didn’t trust the financial system and decided to stash my one million-pound note under my mattress, I would probably spend a lot of money beefing up the security in my house. Alarms, CCTV, bear traps – no expense would be spared. But physically securing an asset is a lot easier to understand than digitally securing something.

I am not an expert in cyber security, but looking at some of the biggest Bitcoin heists in the short history of the currency would suggest to me that it’s not an easy job. Cyber security is a growing and incredibly complex challenge. And unfortunately, the odds favour the criminals/attackers. All they need is to find a single vulnerability in one’s defenses, while defenders need to protect themselves against every conceivable threat.

Blockchain Use Cases in Financial Services

I’m sure that blockchain offers great promise. After all, if financial services are built on trust and if blockchain could—potentially—serve as a “trust machine,” there must be a multitude of opportunities to disintermediate existing intermediaries—whether they be reference data utilities, securities depositories, payments/transaction processors or trade financers.

But I’m sceptical as to whether all the hype will live up to expectations. The origins and previous application of the technology also fuel my scepticism. The creation of Bitcoin is shrouded in mystery (the Satoshi Nakamoto saga sounds like something from a spy novel). Yet its role in greasing the wheels of the underworld economy—facilitating the purchase of everything from drugs to hitmen on marketplaces like Silk Road—is undeniable.

Much of the Bitcoin community either wish to avoid the financial industry (and associated authorities), or actively oppose “the system.” Yet that very system is now scrambling to adopt their technology. It seems counterintuitive. Actively embracing a technology that is highly complex, computationally intensive (potentially wasteful) and much of whose know-how resides with people that oppose your existence … does that make complete sense?

Being a blockchain sceptic is not a particularly popular position to take at the moment. It’s been likened to believing the internet would never take off. Yet the internet presented a much simpler value proposition. Blockchain and its potential role as a trust machine is, in my opinion, considerably more complex.

This blog was first published via the Tabb Forum

Footnotes: