5 questions about the future of blockchain

What a difference a year makes.

Lamborghini after Lamborghini rolled up to last year's Consensus event in New York, considered the premier event for the crypto world. But bitcoin has since plunged in price to $3,000 from $20,000 (though it has rallied recently) and the flashy, expensive cars were nowhere to be found at Consensus 2019.

Almost as an acknowledgment, experts and entrepreneurs presenting in the New York Hilton Midtown addressed both the volatility of cryptocurrency and the potential of its underlying technology, blockchain.

“Count me as a crypto skeptic,” said the Nobel Prize-winning economist Eric Maskin. “It’s a dubious store of value and I worry that we’re replacing government fiat currency with private money.”

While bitcoin has suffered, blockchain and cryptocurrency experiments have gained more adoption with incumbents, including Wall Street banks.

“We don't get scared when it's a down market and we don't get too excited when it's an up market,” said Paul Veradittakit, partner at the blockchain investment fund Pantera Capital. “Now that people are accumulating cryptocurrencies, both consumers and institutions, we want to be backing staking and lending and services on top of the assets.”

Economists, investors, crypto lenders and regulators gathered at Consensus 2019 to discuss trends and issues in digital currencies. Following is a look at those issues and wider debates over where the industry is headed.

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What are banks waiting for?

While some banks are still bullish on blockchain, many remain firmly on the sidelines. A big debate is whether and when and whether that will change.

Most don't appear to want to jump into the debate until blockchain is more mainstream, said Tom Glocer, lead director of Morgan Stanley’s board of directors and the executive chair and co-founder of the cybersecurity services firm BlueVoyant and the capital markets tech startup Capitolis.

“The right strategy at the moment is not to take your entire equities franchise and suddenly push it onto a blockchain because of the inefficiency and because of the security issues,” Glocer said. “Rather, it’s better to run a series of controlled experiments.”

And then there are the risks banks have to consider. For example, blockchain provides new opportunities for hackers, said Nadav Zafrir, CEO of the cybersecurity think tank Team8. As the world becomes more connected, there’s a greater chance that a hacker could topple a longer chain of dominoes, he said.

Consumer and commercial attitudes come into play here too. For banks to fully embrace crypto, there needs to be trust in it. But we're not at a point where the majority of the public trusts the technology, Glocer said.

Will regulators get on board?

It's not just a matter of will, however.

Many U.S. banks face regulatory challenges that prevent them from pursuing blockchain projects.

For example, BNY Mellon blockchain lead Lior Glass was researching a blockchain use case for home loans when he was stopped by state regulations that require banks to have paper copies of home loans.

There are broader concerns about whether blockchain projects are really an improvement in certain use cases.

“Distributed ledger technology is not disrupting banks just yet,” said Oleg Abdrashitov, blockchain laboratory director for PJSC Sberbank in Russia. “Until we can tokenize securities and tokenize fiat properly, we will not see new business models. It helps us reduce risk and improve inefficiencies, but banking products are still the traditional banking products.”

Some said the solution will be when regulators — specifically a central bank — create their own stablecoin.

“If we have a nationally recognized stablecoin, and it's released by a smart contract,” Abdrashitov said. “That's where real disruption comes.”
Child playing in sandbox

Would a U.S. blockchain sandbox help?

Fintech sandboxes are a popular vehicle for financial systems around the world to become comfortable with cryptocurrency and blockchain. But there are issues with adopting one in the U.S. given regulatory constraints.

“A sandbox can be useful,” said Hester Peirce, a commissioner at the Securities and Exchange Commission. “But you don’t want the parents in the sandbox building the sandcastle. You usually want the kids to figure it out for themselves. It changes the creative process once you have the regulators watching you.”

She said there is a need for some kind of multiagency sandbox-like effort in the U.S. so that different regulators — the SEC, the Federal Trade Commission and the Commodity Futures Trading Commission for example — can figure out which parts of the technology should be regulated by the various federal regulators.

“If the sandbox is something where a company can say, ‘Hey, give us some limited relief, we need to make this work and we’ll be candid with you,’ then that can be an effective thing,” Peirce added.

With fragmented legal approaches toward crypto between the federal and state governments, it may be necessary for Congress to propose legislation not for the purpose of passing it into law but for educating lawmakers, said Rep. Tom Emmer, R-Minn., a member of the congressional task force examining fintech.

“You have to show that our government is interested in creating a safe place for these companies to grow,” Emmer said. “Because of all the things that are changing, you have young kids leaving to go to Europe.”
Branch signs of nine banks involved in the 2017 U.S. stress tests.

Are banks even necessary in a blockchain world?

Arguably the biggest debate in the space is whether banks will still be important given the advent of cryptocurrency.

“For economists, one of the things we like about crypto is that it pushes you back to first principles,” said David Yermack, chairman of the finance department at New York University's Stern School of Business. “It makes you reconsider if we need banks to have banking."

But some say a bankless future would be an error, even if it were theoretically possible. If public money is replaced with private money like cryptocurrency, there is the risk of interfering with the workings of our economy, such as the process in which central banks limit business cycles by adjusting the supply of money, said Maskin, the economist.

“The idea that you could go around banks with cryptocurrency may sound appealing, but banks decide which entrepreneurial projects are promising and which are not,” Maskin said. “If we undermine the banking system we do so at our peril.”

Crypto doesn’t consistently fit with the historic economic criteria of currency, Yermack added, noting that few merchants accept it as payment, it can process only seven transactions a second worldwide, and it doesn't store value because it's so volatile. Additionally, he argued, economists cannot gauge the cryptocurrency market as easily as they can the current financial system. There’s no way for the government to encourage competition so that monopolies don’t pop up.

“If you go by the criteria that economists have used for centuries, meaning that a currency is a stored value, a medium of exchange, a unit of account, bitcoin has never met any of those well,” Yermack said.
Fiduciary panel

Who’s to blame if blockchain goes bad?

If blockchain were to replace the current financial system, developers could face the same fiduciary liability as banks do.

What that duty would look like is a contentious debate within the industry. Some say it comes down to prioritizing between “duty of care” and “duty of loyalty.” The first is about doing no harm, but the second is about serving a customer’s best interest.

“Do I want the developer of Zcash to focus on a protocol that will enrich Zcash holders? No,” Peter Van Valkenburgh, director of research at Coin Center and a Zcash board member, said in describing the duty of care. “I want the developers at Zcash to build the best software to protect financial privacy that can be built. If that means the price of Zcash falls, then so be it.”

The duty of loyalty would mean developers would be liable to stakeholders. In blockchain, however, there are many stakeholders with competing interests, said Vlad Zamfir, an Ethereum developer at the Ethereum Foundation. This includes coin holders, crypto miners and even third parties.

Valkenburgh blames duty of loyalty, or duty to shareholders, for the 2008 financial crisis. The highest bidder for a collapsed Lehman Brothers was the U.S. government, which was considering the price of economic collapse, he argued.

"The question of institutional design is whether or not you will crush the socially beneficial activity if you impose liabilities that will drive everyone away from engaging in those activities," he said.

But duty of loyalty may still be important if developers can write things into the code that no one else knows, said Angela Walch, professor of law at St. Mary’s University School of Law.

“I would be surprised if people would be OK with bitcoin core developers being paid by a particular exchange outside the system to push certain strategies,” Walch said. “Without duty of loyalty there, there’s nothing preventing that.”