Blockchain Won't Make Banks Any Nimbler

In 1855, Karl Benz combined his profession of manufacturing internal combustion engines with his hobby of designing carriages to produce the first autonomously powered mobile carriage —the automobile. Benz introduced an engine as a solution to a specific engineering problem: to make a carriage move quickly without a horse. The engine supplanted the horse; it did not make horses faster.

In 2008, a similar engineering problem was solved by Satoshi Nakamoto. He combined cryptography and peer-to-peer networks to produce bitcoin, the first fully electronic cash. Nakamoto introduced the bitcoin blockchain as a solution to a specific engineering problem: to move money online in the same way cash is transacted in person without a trusted third party.

So despite banks' attempts to test and use blockchain technology for their own commercial gain, it is outside the realm of possibility for the technology to serve any useful purpose for the intermediaries it was designed to replace. That is akin to burdening horses with engines in the name of technological innovation: the approach would only slow down the horse and alleviate none of its problems. Such a ridiculous notion will find no real world demand.

When two parties transact with bitcoin, the transaction is broadcast to all network computers that expend significant processing power to verify all transactions and to verify each other's verification.

This highly complex iterative process lets the network achieve consensus on one unalterable record of transactions that are inscribed in a chain of blocks. It also rewards members with new bitcoins that are roughly in proportion to the processing power they spend. This approach is computationally intensive and an expensive method for verifying transactions. That explains why the network's processing power today has exceeded 1 Exahash per second — dwarfing the world's largest supercomputers — and also why it consumes enormous amounts of electricity.

There are many easier and less cumbersome ways of recording transactions, but this is the only method that eliminates the need for a trusted third party. A transaction is committed to the blockchain because many verifiers compete to verify it for profit. Yet not one of them is relied upon or trusted for the transaction to go through. Rather, fraud is immediately detected and reversed by other network members who have strong incentives to ensure the integrity of the network. In other words, bitcoin is a system built entirely on cumbersome and expensive verification so it can eliminate the need for any trust or accountability between all parties: It is 100% verification and 0% trust.

Only time will tell whether this model will supplant traditional forms of finance that utilize simpler technologies but continue to rely on trust and multiple layers of intermediation in various degrees. It is possible that bitcoin will grow to displace many financial intermediaries. It is also possible that bitcoin will stagnate or even fail and disappear. What cannot happen is bitcoin's blockchain benefiting the intermediation that the digital currency was meant to replace.

For any trusted third party carrying out payments, trading, or recordkeeping, the blockchain is an extremely costly and inefficient technology to utilize. A non-bitcoin blockchain combines the worst of both worlds: the cumbersome structure of the blockchain with the cost and security risk of trusted third parties. It is no wonder that seven years after its invention, blockchain technology has not yet managed to break through in a successful, ready-for-market commercial application other than the one for which it was specifically designed: bitcoin.

Instead, there has been an abundance of hype, conferences and high-profile discussions in media, government, academia, industry, and the World Economic Forum on the potential of blockchain technology. Many millions of dollars have been invested in venture capital, research and marketing by governments and institutions that are seduced by the hype, without any practical result.

Blockchain consultants have built prototypes for stock trading, asset registry, voting and payment clearance. But none of them have been commercially deployed because they are more expensive than simpler methods relying on established database and software stacks, as the government of Vermont recently concluded.

Meanwhile, banks don't have a great track record in applying earlier technological advances for their own use. While JPMorgan Chase's CEO Jamie Dimon was touting blockchain technology in Davos last week, his bank's Open Financial Exchange interfaces — a technology from 1997 to provide aggregators a central database of customer information — had been down for two months.

In contrast, the bitcoin network was born from the blockchain design two months after Nakamoto presented the technology. To this day, it has been operating uninterrupted and growing to more than $6 billion worth of bitcoins. The blockchain was the solution to the electronic cash problem. Because it worked, it grew quickly while Nakamoto worked anonymously and only communicated curtly via email for about two years. It did not need investment, venture capital, conferences, or advertisement.

There are many simple technologies banks need to optimize and to improve to enhance their products. Instead, they are seduced by the siren song of futuristic buzzwords and searching for a problem to solve with a blockchain. But they won't find anything.

Saifedean Ammous is an assistant professor of economics at the Lebanese American University.