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Banks using the bitcoin blockchain is like putting a bird in a cage

The Bitcoin community have been educating me lately in how their currency can not be regulated.

This stems from my assertion that money was created to control people and therefore you cannot have money without government.

The Bitcoin guys tell me that once you’ve converted your currency into bitcoins, then you can trade that currency anywhere globally without government control.  Once it’s on the blockchain, the money becomes anonymous (apart from IP addresses).

So has government, the system and control failed?  Can you have an internet system trading commercially without control?

Yes, according to the Bitcoin community.

The claim that Bitcoin and other communities are trading without control.

The thing is that, as soon as their trades become visible in the physical world, the assertion that governments cannot control such trading becomes false.

Think about it.  You can trade across borders globally using bitcoin for any digital exchange of value.  Purchase music, books, movies or such like for nothing.  Well, that’s nothing new as people already get music, books, movies or such like for nothing.  It’s called BitTorrent.  The dark net and free trade of digital value exists extensively already without bitcoin.

Then we get into using bitcoin for money laundering and terrorist funding.  Well that exists already via dollar movements of physical notes.  That’s not something that changes fundamentally with bitcoin although it does become easier possibly

But when we get into using bitcoin for drugs or trading cars, clothes or physical goods, it releases control again.  After all, these goods have to cross borders physically via an import mechanism.  As soon as you have a physical import process, you have government inspectors. 

Therefore, I can see a system without government control that the Bitcoin community expound, but I cannot see a complete wild west of trading in bitcoin as the physical controls will remain in play.

Any thoughts?

Meanwhile, a really interesting exchange with the Bitcoin community about my other statement: that the blockchain is of interest, but it doesn’t require the currency bitcoin to use the blockchain.

From discussions with the banks, they are all thinking about how to incorporate the blockchain protocol into their transactions.  This is to reduce costs and to create a global ledger of counterparty activity that is secure and held in the net for all to see.  That’s how the blockchain works for bitcoin.  However, the Bitcoin community always say you cannot have a blockchain without the bitcoin currency, so here goes.  Here is the exchange between myself and the bitcoin twitterati over the past day or so that clarifies a lot.

First, Jon Matonis retweeted my write-up of our cryptocurrency evening at the Financial Services Club.

In that write-up, I noted that the Bitcoin folks state “that you cannot separate the bitcoin currency from the bitcoin protocol, but that is exactly what is happening (see Richard Brown's excellent blog on this subject for more).  The blockchain is the key technology that is important for banks.”

Dan McArdle, a New York Bitcoin aficionado, picked up on this and said: “for what it’s worth, @jonmatonis is right re bitcoin the currency being inseparable. Blockchains must record in a native unit; ie, bitcoin.”

I replied that the “blockchain could be used to record other currencies than bitcoin though?” thinking that banks could use this to record $:€ or any other currency trades.  That is what banks are looking to do and the fact that Dan says ‘a native unit’ doesn’t mean it has to be the bitcoin unit.

Dan replied:  “In the sense that third parties can say or guarantee that bitcoins represent something else, yes, but the blockchain is still going to record transactions in bitcoin units. Blockchains require the native unit.”

I still think the Bitcoin guys are confusing here.

For example, Dan says that the “key point is that it's broken to say the blockchain is great but the currency is uninteresting.  The former requires latter”, and this got several thumbs up from the Bitcoin crowd.

My view is that the blockchain is a technical protocol that could be applied to another base currency unit – the dollar for example.  This is why I countered that, “as an open ledger, the blockchain can record any transaction … it does not force buying bitcoins to use the blockchain?”

Dan says: “It does! It's an open ledger only of bitcoin-denominated transactions; eg, Address-A sent N bitcoins to Address B is the record.”

Welly from Ripple joined in: “no, Blockchain can process transactions only in BTC, and no other asset – no exception.”

Me: “surely not if the blockchain protocol is used in a completely different context, e.g. to record transaction between banks.”

Dan: “If you remove the native unit, you have a centralized system. In which case, normal databases are faster and better.  The excitement is that we can enable efficient decentralized exchange of any asset via blockchain representation.  But it has to use a native crytpo unit underneath. Else we lose decentralization  and thus we don't need a blockchain.”

This is the most important answer so far, as it makes it clear why thinking about using the blockchain in a non-bitcoin context makes its core raison d’etre null, according to the bitcoin community, e.g. you only need bitcoin for decentralisation of exchange of value in an open sourced network.  As soon as you try to control that exchange, you might as well have a centralised system and then you don’t need the protocol, technology or use of a cryptocurrency.

Richard Brown of IBM joined in: “If you want decentralisation/censorship resistance/no central control, you need a native currency,”

Me: “that's why the banks and governments are trying to adopt the blockchain … to create control.”

Dan: “I think they're legitimate in trying to use blockchain ledgers, or Bitcoin itself, where it creates efficiencies. But there's not enough understanding of appropriate fit yet and the technology is rapidly advancing too, obviously.”

Richard: “I agree. I find using the term ‘ledger’ slows understanding since that isn’t how it works!”

Others joined in too, but we didn’t hashtag the conversation so you’ll have to make do with my summary here I’m afraid.

And if you want to learn more, read a beginner’s guide to cryptocurrencies courtesy of @MrSilverCider @StartJOIN; and a detailed paper on where Bitcoin is today courtesy of @NickSzabo4

Meanwhile, I still don’t agree that you must trade in bitcoin to use the blockchain as the protocol could be linked to any cryptocurrency structure, including one the banks invent for their own use potentially.  Or maybe I’m just pushing the question to see where it goes.

Thanks to @BitcoinRat @jonmatonis @gendal @JustusRanvier @robustus @rat @tek_fin @AdmiralLeviathn @bengraham @cryptolachat @StellarOrg @Ripple @paypebble @wsculley @doctorgoss @NickSzabo4 @mark_a_howard @mmeijeri

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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  • Hi Chris
    The @BitcoinRat is working on a Blog post that will examine the options available for the Banks ( now that they have finally accepted that the blockchain innovation is here to stay and that it will also have a severe disruptive effect on their traditional business models going forward. )
    Interesting times !

  • In reply to your final paragraph:
    In order to use THE Bitcoin Blockchain you must use the native token that represents value on THE Bitcoin Blockchain (which is called “bitcoin” by convention). Since it is not completely fungible (in the same sense that a dollar bill isn’t – it has a serial number, otherwise it pretty much is) see @gendal recent blog posts), it can be used to represent other things. Or whatever the banks choose if they choose the decentralised solution that is Bitcoin.
    If a bank chooses to use A Blockchain (their own centralised version-which would be stupid anyway as the centralised database would be faster – ala VISA/Mastercard), they can make that token whatever they want, but it will still be a native token to that Blockchain. Otherwise, what would be the point of that blockchain.
    It is semantics, but a bitcoin is the native token of the Bitcoin protocol. Whatever you want to call it and whoever is creating the blockchain (banks etc) there must be a native token.
    Or more simply, if their is no native token, there is no blockchain as there are no blocks of transfer of said token to create a chain of blocks….

  • Chris Skinner

    Thanks guys
    I guess this is what I am teasing out here: that you could take the idea of a blockchain protocol and apply it to another native currency. The issue is then why would you want to do that in a control structure that is centralised versus a decentralised structure that is open?
    For banks and governments, they are looking at this as a cost reduction opportunity.
    For citizens and technicians, we are looking at this as a way of creating unrestricted trade without government control.
    The issue hits to the core of how society and civilization works, imho, as money without government undermines the whole reason why we have money in the first place. That’s why I’m talking and blogging about it so much.

  • Hi Chris,
    Thanks for writing this up – very helpful. I think several distinct concepts often get mixed up.
    The first is: how do you build a decentralised/consorship-resistant/etc ledger system? The bitcoin breakthrough was to combine game theory, economics and computer science to create a system where a ledger-like system can be secured through the efforts of unidentified, diffuse actors, acting in their own interest and such that no single actor can exert control… Such a system requires an incentive structure for the security providers – and that’s the mining reward. Hence why you need a native token. The logical pillars are mutually reinforcing — remove one (e.g. the native currency of the “ledger”) and it all falls down.
    However, there’s nothing to stop participants agreeing that a small amount of this currency cannot represent something else, potentially worth much more. e.g. you could imagine $1bn of IBM bonds being “carried” on bitcoins worth only a few cents. So that’s one argument for how one *might* separate the currency unit from its applications….. sure – the currency unit is still there but its economic relevance is fairly small in the context of the asset-registry use-case.
    The second thing you can do is take the insights of the design (blockchains, distribution of security providers to prevent a single actor subverting the system) but soften some of the assumptions. e.g. if you are prepared to sacrifice total decentralisation, you could imagine a half-way house, where those providing the security infrastructure are known and maybe even have agreed to SLAs with each other, etc. Such a system is easier for third-parties/governments to control/subvert, of course…. but there are still advantages to the system: such actions become visible and they require those seeking to influence the network’s behaviour to influence *multiple* actors — hence providing a higher barrier to action and so forth. And the key point here is: in this scenario, you don’t need a native currency… the identities of the “security providers” are known and you can just pay them directly in GBP!
    Now, one could argue that alternative systems (e.g. Ripple) are better for the latter use-case but I think it’s these two scenarios that mean the situation is greyer than it might first appear.

  • I tend to agree with Ben. At core technology wise, its about comparing to types of data storing architectures. A centralised database (Nosql for example) which provides superior performance in many fields (with maybe exception of security) and a decentralised blockchain database which can be superior in specific cases i.e. trustless multi party environments or when highly auditable data storage / manipulation is necessary. The uses cases for such a technology maybe non currency (most likely in my view). Delegation of mining (or other proof validation) could be possible without having to create a currency paradigm. i.e. I contractually delegate the technical “processing” of my blockchain to 4/5 independent parties which in pay in $ for example.
    This is where things are becoming interesting when building blockchains as a flexible technical platform (more to come soon)

  • If we can simplify the analogy perhaps we won’t get bogged down in the weeds. Bitcoin is a global lottery system that rewards players with tokens that are, at the start, worthless. It is only because this global lottery system *happens to* – as a side effect – allow for near-instant and near-costless transfers of the tokens, that these tokens accrue value in the eyes of the players and other participants.
    If a limited entity such as a bank were to attempt to use this system, internally, what would that look like? Well their primary goal would be to remove counterparty risk, which the primary design benefit of Bitcoin. The others, i.e. the global lottery system, they don’t need, since their nodes are all known, internal, and trusted. But it turns out neither do they need the consensus truth Bitcoin provides, because they create their own truth. There is no counterparty when transferring value within the entity. It is all “us”, there is no “them” to worry about. So now it has become all but useless.
    They might think, well then: we need a consensus truth for interbank transfers, within a consortia of our peers. Let’s use it there! So they sign up, let’s say, 250 other banking/financial entities to begin using a private Bitcoin lottery system to package sets of transactions into a shared consensus blockchain. They have achieved a distributed consensus ledger, but one final bugaboo remains: The tokens used on the ledger have no value.
    “Why don’t we all agree,” they announce, “for the sake of this shared system, to peg each token to be valued at one USD, for simplicity’s sake. We have no need for any other unit of value, especially one which floats around and cannot be predicted.” To allow for this, they change the lottery prize from a 21M scheduled deflationary reward to be inflationary, tracking exactly, through an externalized oracle, the universal supply of dollars in the “real” world.
    The end result is a collection of transaction processors using a token of value that is tied to an external value system – the center of this blockchain system is valueless. The tokens in circulation are of course not really dollars, they only represent dollars, and as such the agreement among the entities must hold that they will honor blockchain transactions and send the _actual_ value in dollars when a broadcasted “transaction request” (not actual transaction as in Bitcoin) is encapsulated onto the shared blockchain.
    We unfortunately we no longer have a system that is impervious to counterparty risk. Any of the entities could refuse to recognize the validity of any blockchain transaction, and thus there is no distributed consensus. They have failed to see the hidden magic within the system, only understanding the surfaced benefits, and thus have killed (or neutered) the goose to obtain the stash of golden eggs inside.
    This is why it is so hard to explain why one cannot simply piggyback on Bitcoin-the-network’s benefits without accepting bitcoin-the-token’s value as well. The price of BTC IS the value of the Bitcoin network of shared consensus, the only way that it can be expressed.

  • I’m sorry, but you seem to assert the notion that Bitcoin itself has no use in the modern world because there are already solutions to many of these things and BTC offers nothing new. What about the micropayment question on the internet. Does a system with little to no fees (Bitcoin) outcompete lets use Paypal for example, that charges 30 cents plus 2.9% on every transaction? Or what about the 2.5 billion people in the world with no form of banking. Or the 6 billion that are severely underbanked. Would a peer to peer system like Bitcoin make it easier for this large population to connect and transact with the rest of the world considering the fact that over 80 percent of these people use cell phones? There is also a big opportunity in the money remittance market and allowing people to transmit money across borders for legal purposes without paying 10 to 20 percent in fees that Western Union make us accustomed to. You might be right in terms of the average American or European, but I see Bitcoin having a huge competitive advantage in emerging markets around the globe and bringing these people up to speed with the rest of the world.

  • Chris Skinner

    I’m not saying that bitcoin has no use. If it was not of use, it would not exist and have the thousands of people developing around it.
    Bitcoin absolutely needs to exist and has a purpose as a value exchange. However, whilst it purports to be a currency, it has a weakness in that is has no guarantees or protections for those who use it, as demonstrated by MtGox. That is why regulators and banks will circle around bitcoin until it offers the same consumer protections we have with money.

  • The paradox is that ambassadors of bitcoin are killing it. They announce that we have a new fantastic mean of transaction, which for 100% will be worth more in the future.
    If you believe, you don’t spend it.
    Moreover this believe is already included in current price. So the bet is that I believe more than other believers.
    Is there a limit of belief?

  • You can view the bitcoin token as a unit of account for incentivising the provision of security services for the blockchain. Software cant measure scarcity of an issued asset from Bob’s bank because it cant know what Bob’s bank’s credit rating is or if it even has one; and if Bob is a prankster its scarcity is not limited at all. Bitcoins in contrast are network issued, and are a virtual scarce commodity, gold-like but with instant real-time assay: the network can conveniently and instantly check their scarcity.
    Now for a blockchain to remain open for innovation it cant natively discriminate between Bob’s bank and the Bank of England, thats a human judgement as to which will act more prudently. We can’t rely on Bob not to spam the blockchain (to the point of disrupting service) using a bazillion Bob coins, each of zero market value, therefore the only answer is that transaction fees must remain in bitcoin to use the bitcoin blockchain (or sidechains denominated in bitcoin). The BoE is a more prudent than Bob, but perhaps not completely immune to moral hazard. Certainly over the long term fiat currencies have fared very badly against gold, and inflation even amongst the better run currencies has reached rates that affected the respective economies.
    Technically you could rely on a market to price issued assets, and miners could then accept fees paid in them, if there was a BTC denominated price. However unless the miner’s operator specifically and manually says he is happy with Bob’s coin it would be a network security risk for miners to automatically accept them as the BTC-BOB liquidity could be near zero, artificially manipulated by Bob alone buying a few coins from himself, or the market may collapse overnight (when Bob prints a bazillion coins on a whim). So the miner, unless manually configured, would have to actually trade for bitcoin, and therefore it would be more direct and simpler to just expect the fees in bitcoin.
    Bob in the example might be Zimbabwean dollar, without the story being far different.