The next big thing

ASKED TO NAME an event that has reshaped finance in recent years, bankers will point to the collapse of Lehman Brothers on September 15th 2008, the nadir of the financial crisis. Fintech types are more likely to mention something that happened six weeks later. On October 31st 2008 Satoshi Nakamoto, a pseudonymous cryptography buff whose real identity remains a mystery, unveiled a project he dubbed bitcoin, “a new electronic cash system that’s fully peer-to-peer, with no trusted third party”. It described what appeared to be a robust framework for a currency that could run without the backing of any government. Enthusiasts proclaimed that finance was about to enter the era of crypto-currencies. Since the need for a trusted third party has traditionally been a large part of the banks’ raison d’être, this could mean that in future they will no longer be required—potentially a much more radical change than the other inroads fintech has made on their business.

Six-and-a-half years on, the bankers may feel they can relax a little. Interest in bitcoin has waned. After spiking at $1,100 in November 2013, its value has dropped to $225 (see chart). A few online retailers and trendy coffee bars accept it, but its yo-yoing value is one reason why its use in the legitimate economy is barely measurable (though it remains a favourite with drug-dealers). The general public has not forsaken cash or credit cards.

Interest in the underlying mechanics of the currency, however, has continued to grow. The technological breakthroughs that made bitcoin possible, using cryptography to organise a complex network, fascinate leading figures in Silicon Valley. Many of them believe parts of Mr Nakamoto’s idea can be recycled for other uses. The “blockchain” technology that underpins bitcoin, a sort of peer-to-peer system of running a currency, is presented as a piece of innovation on a par with the introduction of limited liability for corporations, or private property rights, or the internet itself.

In essence, the blockchain is a giant ledger that keeps track of who owns how much bitcoin. The coins themselves are not physical objects, nor even digital files, but entries in the blockchain ledger: owning bitcoin is merely having a claim on a piece of information sitting on the blockchain.

The same could be said of how a bank keeps track of how much money is kept in each of its accounts. But there the similarities end. Unlike a bank’s ledger, which is centralised and private, the blockchain is public and distributed widely. Anyone can download a copy of it. Identities are protected by clever cryptography; beyond that the system is entirely transparent.

As well as keeping track of who owns bitcoin today, the blockchain is a record of who has owned every bitcoin since its inception. Units of currency are transferred from one party to another as part of a new “block” of transactions added to the existing chain—hence the name. New blocks are tacked on to the blockchain every ten minutes or so, extending it by a few hundred lines (it is already over 8,000 times the length of the Bible).


The proposed transactions contained in new blocks do not have to be approved by some central arbiter, as in conventional banking. Rather, a large number of computers dedicate themselves to keeping the system running. Rewards are high enough for vast data centres across the world to want to participate. Known as “miners”, they authenticate transactions by reaching a consensus on what the latest version of the blockchain should look like. In exchange, they are given newly minted bitcoin.

Chaining blocks together sequentially prevents anyone spending the same bitcoin twice, a bane of previous digital currencies. And the system is beyond tampering by any one party. Unlike a bank ledger, which can be altered by its owner (or a government), the blockchain cannot be changed without simultaneously overwriting all of the thousands of copies used by the miners at any one time. The definitive version of the blockchain is whatever a majority of the participating computers accepts. None of them is connected to any centralised organisation. There is no bitcoin central bank to sway them. To overwhelm the system, someone would need to control 51% of the computing capacity of the 10,000 or so “miners”—not impossible but unlikely.

This system of consensus by distributed co-operation sounds complicated, but it allows something of value to be transferred from one person to another without a middleman to verify the transaction. Fans think this is a way of changing the centralised, institution-dominated shape of modern finance. It is genuinely new. The question is whether it is useful

Proponents envisage an “internet of value” that can make money flow as freely as data are flowing already. Ridding the world of credit-card fees and foreign-exchange charges would be merely the first step of a much broader revolution. In the same way that e-mail did much more than replace letters sent in stamped envelopes, the internet of value would be a platform for myriad as-yet-unthought-of innovations. Just as nobody forecast social networks, blogging or Netflix in the 1990s, the absence for now of any tangible applications other than bitcoin for the blockchain merely points to humankind’s deficient imagination.

All that is needed, blockchain boosters argue, is a “killer app” to find a use for the breakthrough, in the same way that web browsers made the internet useful. Some still think that a currency is the most promising application, but plenty of engineers are throwing other ideas against the wall to see what sticks. CoinSpark, based in Tel Aviv, is among those who want to be able to add messages to the bitcoin blockchain. That would be a way of cheaply notarising information: once something is in the blockchain, it cannot be removed (crypto-geeks post their wedding vows there). Lighthouse, developed by Mike Hearn, a former Google engineer, runs a decentralised crowdfunding platform on bitcoin. Neither of these are killer apps, but they may lead to something bigger.

Now for the tweaks

Techies are (just about) united in their enthusiasm for decentralised ledgers, but divided on whether bitcoin’s blockchain can work in its current form or whether an improved version is needed. Rival blockchains are nothing new: alternative currencies inspired by bitcoin, dubbed “alt-coins”, have proliferated ever since it was launched. Some are quasi-Ponzi schemes where the currency’s founder (and so default owner of much of the blockchain) profits when he sells bits of it to newcomers. Others have re-engineered Mr Nakamoto’s blockchain to make it more suitable for non-currency uses.

Critics point out that bitcoin in its present form can process just seven transactions per second, whereas a large credit-card company like Visa can comfortably take on tens of thousands. Users may have to wait up to half an hour for a transaction to be processed, and mining guzzles a lot of power.

But enthusiasts say the blockchain is so robust precisely because of the large number of miners involved, and point out that it has survived untold numbers of cyber-attacks. Alas, using hacker-proof bitcoin requires going through intermediaries such as exchanges to convert real-world currency into crypto-cash, and “wallets” to store it. These have proved anything but secure, which arguably defeats the purpose of bitcoin’s trust-free world.

New blockchains far removed from currencies are being spawned. Ethereum, widely seen as the most ambitious crypto-ledger project, wants its blockchain to go beyond transferring value: it should also be able to execute simple tasks such as verifying if a party to a contract has fulfilled its side of the bargain. Its boosters think such a machine could support “smart contracts”, where a computer can verify or enforce an agreement. The next step is for robots to go into business for themselves, for example a computer server renting out processing capacity, and using the profits to upgrade itself.

That, for now, is science-fiction. In the short term, distributed-ledger technology is far more likely to be used by incumbents in financial services. The New York Stock Exchange in January bought a stake in Coinbase, a bitcoin wallet, in case stock exchanges decided to go for decentralisation. Banks think that some of the plumbing for settling financial contracts could be decentralised, too, perhaps with their own private blockchains. Payment networks are also keeping an eye on blockchains, attracted by their tiny transactions costs. If a network like Visa were to be built today, it would almost certainly be decentralised, says Jim McCarthy, its head of innovation.

One well-funded new blockchain is Ripple Labs, which wants to enable “secure, instant and nearly free global financial transactions”. It is working with financial incumbents to draw up a payment protocol based on decentralised ledgers. Its aim is not to supplant the current financial system but to make it more efficient. “We are builders, not disrupters,” says its boss, Chris Larsen, a veteran of the fintech scene who founded Prosper, a lending platform. The problem Ripple is trying to solve is not the omnipotence of the banks but the antiquated way that money is transferred among them. At present two banks in different countries have to use one of a handful of large “correspondent banks” to transfer money between them. With Ripple, they should be able to interact directly.

Seasoned crypto-anarchists are not excited by the idea of reforming the global banks’ back offices. Some complain that Ripple is taking an idea with the potential for revolutionary innovation and using it for something far more humdrum. Yet if Ripple succeeds in bringing a critical mass of the banks onto its platform, it will have rendered a service similar to the people who turned a raft of disparate academic computer networks into a single internet in the 1990s. That is not to be scoffed at.

All large banks already have teams poring over blockchain. Many of their back-office settlement platforms seem destined for a move to decentralised ledgers. One barrier is the difficulty of finding staff who can get them up to speed on the technology. “The sort of people who understand blockchains don’t usually want to put on a suit and go work for a bank,” says Gideon Greenspan of CoinSpark. Because they lack central administrators by definition, blockchain-based systems are unforgiving: there is no helpdesk to reset a lost password, say. Bank bosses may be tempted to stick with the slower, pricier systems they know.


Are blockchains here to stay, in one guise or another? “Just because bitcoin didn’t succeed as a currency doesn’t mean blockchain will succeed as a technology, but the experiment is important to run,” says Patrick Collison of Stripe, a payments processor. The possible uses are legion, but the killer app is still missing.



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