Is Blockchain the solution to everything?

Is Blockchain the solution to everything?


Written by Adolfo Morán

The American philosopher Abraham Kaplan developed what is known as the “Law of the Instrument” which is often represented with his famous phrase “give a child a hammer and he will think that everything he encounters needs a hammering”. The Law of the Instrument alludes to the fact that when we seek solutions to different problems, we tend to make use of the same method or the same tools. Is blockchain Kaplan’s hammer?

Currently, blockchain technology is being tested in different industries due to the promise that, implemented this technology, information transfer processes and storage security will be optimized, being Blockchain seen by some almost as a panacea. However, there are many technical and legal issues that must be taken into account for a proper adoption of this technology.

In that sense, there are three general issues that players in every industry, and especially the financial industry, should consider in order to evaluate the convenience of introducing blockchain technology to their processes: (i) privacy, (ii) automation and (iii) timeliness. The issue of privacy, both in the access, verification and handling of the information recorded in a Blockchain, as well as in the permissions to enter such information, must be taken into account according to the type of industry. For example, different levels of privacy are handled in the financial sector compared to the retail sector, as the actors involved in these sectors are not subject to the same risks.

In this sense, financial companies are subject to legal obligations that seek to mitigate a series of risks, such as operational risk, which includes the risk of failures or errors in the technologies used by financial companies, as well as the duty to keep confidential the information considered bank secret. Taking this into account, systems such as Bitcoin or Etherum, which make use of a public Blockchain, which are managed in a completely decentralized manner and anyone can access the registered information, do not seem to be the best option for financial companies, as they could be for companies in the retail sector.In fact, in the latter case, there are proposals to create Dapps (decentralized applications) on the Etherum protocol that function as e-commerce stores, where, through the use of Smart Contracts, the purchase and sale of products is carried out automatically.[1] It would be difficult to see a financial company, such as a bank, operating on a Blockchain, at least not in a public one.

This does not mean that financial companies cannot make use of blockchain technology, but that they might want to evaluate private options such as Hyperledger Fabric or Corda, which have been designed with the needs of the financial sector in mind.

The second issue to consider is automation. The original idea behind Blockchain is the elimination of traditional intermediaries; for example, banks and payment gateways. This is achieved through the use of a peer-to-peer network through which nodes (computers) are the ones that verify and validate transactions.

This works on the basis that, instead of relying on banks to handle money transactions correctly, the trust that the transaction is properly completed rests with the system itself, so it is often said that trust is placed in the code itself and no longer in the intermediaries.

All this leads to an increasingly automated environment, in which Smart Contracts[2] are executed immediately after the conditions established in their codes have been verified and fulfilled. The downside of this automation in a Blockchain is the difficulty in stopping and reversing transactions or, in general, the difficulty in modifying information that has already been entered in the Blockchain, either by the programmers’ own will or by execution of an award or judgment.

Currently, there is much discussion about whether the use of Smart Contracts is really efficient in B2B contracting. While the idea behind Smart Contracts is to reduce costs in the execution of a contract, facilitating the tasks of monitoring and verification of compliance that is usually carried out by people, it is not entirely clear that such savings in execution costs actually represent an advantage over the higher costs in the application of legal remedies.[3] In this regard, financial companies that want to make use of blockchain technology should consider the automation inherent in the Blockchain.

Therefore, financial firms that want to make use of blockchain technology should consider the automation inherent in the Blockchain so that they implement this technology in a way that is an efficient complement to it.

Finally, there is the opportunity in the use of the Blockchain. There is currently a lot of hype regarding this technology, which is considered by many to be a disruptive technology that establishes a new paradigm in Internet relationships. However, although the adoption of blockchain technology is a trend and not a fad, it will not always be necessary to make use of a Blockchain.

This happens, for example, in the case of High Frequency Trading (HFT) platforms, technology used in capital markets for trading and asset transactions (front end), which are effectively used worldwide to perform transactions in a few seconds. However, unlike HFT, the clearing and settlement processes (back end) have never been so fast (e.g. T+3).

Thus, although the use of a Blockchain could unify these processes, so that by simply carrying out the transaction the corresponding clearing and settlement is also performed, current systems based on blockchain technology do not yet have sufficient capacity or “scalability” to process a large number of transactions per second, which places it below HFT in terms of transaction speed.

Thus, one has to wonder what are the costs vs. benefits in making use of a Blockchain, whether public or private. Another case, in relation to tracking or tracing things or goods, one of the most popular uses of this technology, involves always analyzing whether the same result can be achieved using a centralized database instead of a decentralized one.

For example, it would do some good to use a Blockchain for processes in the mining sector, such as to track and record in an “immutable” way that the minerals extracted from a given mine have actually arrived at the port of shipment. We believe that this can be achieved with good logistics and a centralized database.

The opposite is the case with diamond certifications, which seeks to combat illegal trafficking or the well-known “blood diamonds.”[4] In these contexts, companies such as Everledger and Tracr have taken advantage of blockchain technology to certify the origin and authenticity of the diamond being traded.

 

What is the difference? In the first case, we are talking about a mining company that has the right granted by the government to exploit a mine and we assume in a conflict-free zone; in the second, we are talking about diamonds that are extracted in conflict zones by different people and companies, where due to the commercial dynamics, it is difficult to know exactly if these diamonds have an illicit origin or not.[5]

However, the problem in the exaggerated use of this technology often has as its origin the blind interests in having a “successful project”, which achieves a great financing, which forces entrepreneurs and start-ups to “use” the Blockchain, even if the utility is minimal or null.

Indeed, as Jimmy Song points out, integrating blockchain technology to your project is a way to be with the latest technology in the market or, better said, with cutting-edge technology. This clearly serves to attract investors, who often do not know what Blockchain will be used for in the project in which they will invest.

In conclusion, there is no doubt about the potential of using blockchain technology. However, we should not see it as that hammer with which we can solve all problems and that will necessarily optimize operational processes. The implementation of a Blockchain in a regulated market such as the financial one implies an exhaustive analysis, so that it can be properly determined what type of system based on Blockchain technology is needed, having to consider issues of privacy, automation and opportunity in the use of this technology.

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Page Notes

[1] Some examples can be found here: (i) https://github.com/brakmic/BlockchainStore  and (ii) https://www.elinext.com/case-study/mobile/ethereum-app-for-ecommerce/

[2] Computer codes stored in a Blockchain that can execute obligations established in a contract automatically, as long as the established condition is met; it uses a conditional language [e.g. if (…), then (…)]. In English they are commonly referred to as self-executing contracts or smart contracts.

[3] It is well known that, because a Smart Contract is unmodifiable (unless it has been programmed to modify) and works automatically, it is difficult – if not impossible – for a judge to order, for example, that the execution of the Smart Contract be stopped.

[4] A “blood diamond” or also called “conflict diamonds” refers to those precious stones that come from producing countries involved in war, where the extraction and commercialization of these diamonds is carried out in flagrant violation of human rights (e.g. exploitation of children) and with the purpose of financing the costs of war.

[5] Similarly, blockchain technology is to be used to trace the origin of tantalum, a mineral used in the manufacture of electronic products found in conflict zones in Rwanda.

With these examples we do not mean to say that blockchain can only be used for the mining sector in conflict zones, but we do want to make it clear that it will not be necessary to use this technology in all cases, although it may seem useful.

References

Araya, Andrés. (2018). Andres Araya, Bolsa de Santiago, sobre los retos, limitaciones y oportunidades de Blockchain [Iupana]. Recuperado de http://iupana.com/escuchar_post/andres-araya-bolsa-de-santiago-sobre-los-retos-limitaciones-y-oportunidades-de-blockchain/

Ng, Lance. (2018) Blockchain is Broken. En: Medium. Recuperado de https://medium.com/@lancengym/blockchain-is-broken-1bbb581be5ac

ROBERTS, Jeff John. (2017). The Diamond Industry is Obsessed with the Blockchain. En: Fortune. Recuperado de http://fortune.com/2017/09/12/diamond-blockchain-everledger/

SONG Jimmy. (2018). Why Blockchain is Hard. En: Medium. Recuperado de https://medium.com/@jimmysong/why-blockchain-is-hard-60416ea4c5c