In my previous post on the hype around blockchain, I acknowledged the technology’s potential but warned that many of the much-touted benefits were still a long way off becoming a reality. Instead I urged banks to focus on four key areas—trade finance, on-demand liquidity, capital requirements and payments risk—where they could use blockchain to make short-term gains while laying the groundwork for a long-term strategy.
Yet even within this quadrant of opportunity, the very nature of Bitcoin’s blockchain technology imposes critical restrictions on its effectiveness in a banking environment.
Blockchain refers to a single-state database that disseminates the same information concurrently to all connected parties. Like any database, the processing power of a blockchain is based on how fast it can move data around. Right now, the Bitcoin blockchain technology is unable to process transactions at speeds required by banks. At most, Bitcoin can handle seven transactions per second, whereas Visa averages 2,000 and, if required, can process as many as 56,000 transactions per second.
Not requiring a central counterparty (CCP) to administer the database suggests that the Bitcoin blockchain technology would cut costs. But each transaction still needs to be cleared over a common system. Rather than doing away with the need for a CCP like The Clearinghouse or Euroclear, this blockchain essentially acts as an uber-CCP with all the collateral, margin and regulatory capital requirements associated with the current transaction clearing system.
The challenge that blockchain attempts to solve is how to move value from one party to another and reconcile the changes to their respective accounts. Providing this interoperability requires all parties to be on the same blockchain or accessing the same database. With so many competing blockchain systems, the problems associated with interoperability are far from resolved. In fact, they’re only getting worse.
As a source of truth or record of account, blockchains are useful for reconciling accounts across multiple counterparties. However, this benefit requires each party to have access to the same public database, which raises issues of transaction privacy. Private blockchains are much more secure but only increase the issue of interoperability.
While all of this might dampen your enthusiasm for blockchain’s transformative potential, these limitations are not insurmountable. You just need to be aware of how the Bitcoin blockchain falls short and where to look for even more innovative solutions.
For example, the Ripple Consensus Ledger, which handled payments of more than $1 Billion dollars in 2016, can now process 1000 transactions per second. We also cut global interbank settlement costs by up to 60 percent and use the Interledger Protocol to connect multiple ledgers and guarantee privacy.
Despite all the hype, Bitcoin’s blockchain technology is not perfect. But the future of banking will still revolve around distributed ledgers that overcome current common limitations. And there is one area—payments—where banks can believe the hype right now, which I’ll discuss in the third and final part of this series.