Banks and financial institutions seem to be all over the blockchain. It seems they agree with the Bitcoin community that the technology behind Bitcoin can provide an efficient platform for settlement and for issuing digital assets. Curiously, though, they seem to shy away from Bitcoin itself. Instead, they want something they have more control over and doesn’t require exposing transactions publicly. Besides, Bitcoin has too much of an association in the media with theft, crime, and smut — no place for serious, upstanding bankers. As a result, the buzz in the financial industry is about “private blockchains.”
But here’s the thing — “private blockchain” is just a confusing name for a shared database.
The key to Bitcoin’s security (and success) is its decentralization which comes from its innovative use of proof-of-work mining. However, if you have a blockchain where only a few companies are allowed to participate, proof-of-work doesn’t make sense any more. You’re left with a system where a set of identified (rather than pseudonymous) parties maintain a shared ledger, keeping tabs on each other so that no single party controls the database. What is it about a blockchain that makes this any better than using a regular replicated database?
Supporters argue that the blockchain’s crypto, including signatures and hash pointers, is what distinguishes a private blockchain from a vanilla shared database. The crypto makes the system harder to tamper with and easier to audit. But these aspects of the blockchain weren’t Bitcoin’s innovation! In fact, Satoshi tweaked them only slightly from the earlier research that he cites in his whitepaper — research by Haber and Stornetta going all the way back to 1991!
Here’s my take on what’s going on:
- It is true that adding signatures and hash pointers makes a shared database a bit more secure. However, it’s qualitatively different from the level of security, irreversibility, and censorship-resistance you get with the public blockchain.
- The use of these crypto techniques for building a tamper-resistant database has been known for 25 years. At first there wasn’t much impetus for Wall Street to pay attention, but gradually there has arisen a great opportunity in moving some types of financial infrastructure to an automated, cryptographically secured model.
- For banks to go this route, they must learn about the technology, get everyone to the same table, and develop and deploy a standard. The blockchain conveniently solves these problems due to the hype around it. In my view, it’s not the novelty of blockchain technology but rather its mindshare that has gotten Wall Street to converge on it, driven by the fear of missing out. It’s acted as a focal point for standardization.
- To build these private blockchains, banks start with the Bitcoin Core code and rip out all the parts they don’t need. It’s a bit like hammering in a thumb tack, but if a hammer is readily available and no one’s told you that thumb tacks can be pushed in by hand, there’s nothing particularly wrong with it.
Thanks to participants at the Bitcoin Pacifica gathering for helping me think through this question.