Why banks should stay well clear of blockchain

As much as financial services institutions need to innovate, backing the wrong digital platform could be their undoing

If the financial services industry is banking on blockchain as the basis for new service innovation, it will be sorely disappointed. Blockchain's design principles are completely at odds with those of the industry, and the technology is fraught with flaws that could be catastrophic for financial institutions.

I’ll come on to why in a moment. Clearly, there is a lot of hype and momentum around blockchain. WANdisco sees this first hand: We’re increasingly being approached by banks that think this is the kind of thing we do (it isn’t). And why are they interested? Because senior directors and investors have heard the buzz and concluded that this is something they need—that if they don’t seize the opportunity, they’ll miss out. They’re wrong. Banks need blockchain like a hole in the head.

+ Also on Network World: Financial sector expands use of blockchain databases +

But why do they think they want it? The original blockchain was developed as the mechanism underpinning bitcoin—enabling transactions in a peer-to-peer network to be validated without the need to pass through central settlement systems. Seeing wider potential for this, those promoting blockchain are now positioning the platforms more broadly as distributed public ledgers of transaction. So, banks are starting to look at blockchain for managing real-time transactions.

A lack of trust is no basis for commerce

On paper, blockchain seems to have vast potential. But, in common with many other fintech fads, its current popularity owes more to speculation than genuine potential, and the chances of it realizing that apparent promise are slim.

That’s because the fundamental issues with blockchains aren’t going to go away. First, the whole proposition is built on distrust and on anonymity, shrouded in paranoia. And since blockchains are also highly hackable, disaster is frequently just round the corner. Last year, the DAO, a venture capital fund using a decentralized blockchain, lost more than $60 million worth of Ether digital currency—around a third of its value, when its code was breached. But such is the protection awarded to the parties involved in blockchain-based transactions; it’s impossible to trace the culprits and recover the lost amounts. It’s quite ludicrous. 

There is a social engineering argument around blockchain that does not stack up either—that if someone has enough computer power to hack blockchain, they could make more by minting bitcoin than by wreaking havoc on users. This is based on a misguided assumption that criminals’ aim isn’t to bring down financial systems and cause chaos. Where there’s a will, there’s a way.

The regulated financial industry is founded on trust, not distrust, which relies on parties being known to each other. Unless some kind of shady dealing is going on, it makes no sense to push transactions underground. It’s certainly no way to manage risk. 

A further major sticking point for a financial institution is throughput. Blockchain reconciliations typically happen in periodic batches, which is not good enough for real-time banking. To keep up with the speed of digital business, true values need to be reflected at all times. 

So, again we have to come back to what banks are trying to do that makes them think they need blockchain. What is the use case in banking-as-usual? What is it solving? 

Real-time reconciliation

Dig a little deeper, and what most institutions are really looking for is a robust, trust-based coordinated agreement mechanism for managing very high volumes of real-time transactions digitally across networks. Strategic goals might include making payments more immediate, easier to automate and cheaper to manage. Or it could be facilitating new innovation as the Internet of Things takes off, paving the way for all manner of new distributed transactions along a value chain.

All of which relies on reliability, speed and trust/transparency. Blockchain does not provide that—they weren't designed to.

If I’m a goods or service provider that needs to fulfill a purchase, I need to be sure of cash settlement before activating delivery, and that’s something blockchain will never be able to offer. You can’t see who you’re dealing with, and ledger reconciliations are unpredictable, depending on batch processes and computing queues. The technology was never meant to be used in this way.

So, our message to banks is forget blockchain. Unless the fundamental flaws are addressed, it is wrong for just about anything you might want to do. It’s a bubble you don’t want to invest in. Whatever your intentions, there’s a much more appropriate way to deliver them.

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Copyright © 2017 IDG Communications, Inc.

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