Private 'Distributed Ledgers' Miss the Point of a Blockchain

Bitcoin may have had the most successful marketing campaign of any web technology in recent years. But now there’s a new buzzword making waves throughout the financial industry: “distributed ledger.”

As with many buzzwords, distributed ledger technology has come to mean many things. Some say it's a tool to enable transparency by ensuring that all members of a group receive cryptographically secured messages about participants’ activities. Others suggest that these ledgers will notarize communications. Some are even bold enough to predict that distributed ledgers will end the madness of managing multiple database and reconciliation structures.

While the industry is still working out the details of just what distributed ledgers actually are, the major options seem to have a few things in common.

Distributed ledgers have primarily claimed to supplant the need for Bitcoin's mining process by introducing trust requirements among participants. These ledgers also promise users the immutability of Bitcoin without the need for expensive mining operations. Unfortunately, most of these claims demonstrate a significant lack of understanding about the efficiencies of a blockchain.

One immediate red flag that should jump out at any fan of market efficiency is that the technology powering distributed ledgers predates blockchains by well over 20 years.

The consensus algorithm "Paxos" was one such implementation created in 1989, followed shortly thereafter by "Raft.” It’s hard to believe that such innovations would take 25 years to be discovered in the hyper-efficient world of database design.

Moreover, the inefficiency of interbank settlement services has little to do with technology. The primary reason inter-bank settlement takes days to clear comes down to regulations.

These regulations exist for a number of reasons. Most of them are designed to reduce risk via lengthy, often manual processes. These delays allow banks to reverse transactions if needed.

Proponents of distributed ledgers argue that they can displace centralized providers such as SWIFT, ACH and CHIPS by moving money faster. But distributed ledgers are only more efficient insofar as they are able to circumvent the overhead of regulatory requirements.

There’s no doubt that blockchain technology will facilitate disruptive innovations in finance, much as the Internet facilitated easy public access to information. But a world of private ledgers sounds eerily similar to a range of “private Internets.”

In addition, many of the features offered by distributed ledgers are already available on other systems.

Encrypted e-mail, for example, is a system in which cryptographic receipts are time-stamped and logged by all participating parties. The SWIFT network itself facilitates the exchange of identity-verified and auditable messages. Participating institutions have thus appeared largely satisfied with the reliability of SWIFT’s notarization and auditability. And no institutions have been clamoring to share logs of their activity on this network with direct competitors.

Blockchain technology is useful not because it offers efficiency in a world of message-passing but because it uses a complex process to settle value between untrusted parties. But distributed ledgers do not offer users the ability to easily convert their tokens and messages into fungible units of value. Nor do distributed ledgers escrow value between parties that don't trust each other.

If a ledger is not a public resource, it will have the pressures incumbent to existing settlement systems plus the overhead of maintaining a shared database among competitors. What efficiency will remain thereafter remains dubious.

If distributed ledgers do offer the ability for banks to improve efficiency in their processes, it will likely be because they've afforded banks permission to innovate—not because they’re able to provide settlement to underserved notarization clients.

Chris DeRose is the community director of the Counterparty Foundation