crypto limitations and transferring - effects and results - short study


Blockchain (distributed ledger technology) as a means of storing data
14. Blockchain is an electronic ledger that records and verifies transactions made using
crypto-assets. In its written evidence to the Committee, the Bank of England explained
how blockchain emerged with crypto-assets:
The […] innovations behind [blockchain] emerged from the initial cryptoasset, Bitcoin, which was introduced in January 2009. Bitcoin was an
attempt to build a payment system that did not rely on a trusted authority
(such as a commercial or central bank) to maintain the record of payments
and balances (the ‘ledger’). Importantly, anyone can participate in the
validation of Bitcoin transactions—the network is ‘permissionless’ and its
underlying blockchain (the database or ledger of transactions) is public. The
Bitcoin network relies on multiple participants maintaining identical copies
of the ledger and employs a process to come to consensus on the contents of,
and updates to, this ledger.14

Moving away from its origins with Bitcoin, the Digital Currency Foundation explained
that the term blockchain is now used to describe any database that is distributed amongst
its users that, when it is updated, all users in the system can see the new information and
verify it:
[Blockchain] is a database […] that works as a decentralised […] way of
storing large amounts of data. […] transactions are recorded on a ledger
which are validated and recorded in blocks (hence ‘blockchain’) forming
one timestamped ledger which is distributed and updated over the network
in real time. The validation of blocks is reached through this consensus of
participants in the network […] All blocks timestamped and all transactions
[and information on the blockchain] are accessible to participants.15
16. The uses of blockchain can be extended beyond payments. The following section of
this report considers the advantages and limitations of managing data in this way.
17. Ryan Zagone, Director of Regulatory Relations at Ripple,16 explained the advantages
and efficiencies of a database or ledger that participants share and verify:
Blockchain, as a technology, allows us to validate, store and synchronise
information across many different parties more securely and more efficiently
than we have been before. We are looking at reviewing information for its accuracy and authenticity. 

We are storing it in a way that cannot be
tampered with. We are synchronising it across many different parties,
even globally. Validating, storing and synchronising information has many
different use cases. There is a lot of hype around the technology right now.
People recognise that this type of capability allows us to be much more
efficient in how businesses or commerce can be conducted. There are lots of
use cases for that. It is very general tech.17
18. In its written evidence, the Bank of England also noted that blockchain could
“increase the efficiency of managing data, by reducing data replication and associated
reconciliation processes.”18 Similarly, the FCA’s evidence stated that blockchain could
lead to “cost and time reductions arising from the removal of intermediaries required for
processing a transaction.”19
19. Chris Taylor, Chief Operating Officer of Everledger,20 argued that a key advantage
of storing data in a blockchain form, [over conventional databases], is that it becomes
“immutable” (i.e. it cannot be changed retroactively, except by consensus among users): 

In a traditional database, records can be edited quite easily, either by an
administrator or by other people who have access to the database. In a
blockchain, information cannot be edited. It can be appended to, but the
original information remains as a form of record. That makes it a useful
tool when trying to trace back the history of transactions related to that
database, whether that is related to assets or whether that is related to
currencies and other kinds of transactions.21
Similarly, the Bank of England states that “through the creation of instant, permanent and
immutable records of transactions [blockchain] enhances transparency and auditability.”22
20. Dr Kotsialou, a researcher of blockchain at King’s College London, argued that a
further advantage of blockchain is the resilience and security it can offer:
[Blockchain] is more difficult to hack because the data is replicated to every
node of the network.23 […] [If the data] are replicated in all the nodes of the
network then it is harder to change. It is also the data validation. The rules
that the nodes follow in order to validate votes, or any other transaction, are
all public. Everyone can check what these rules are and everyone can check
that the transactions in a block have been validated in the correct way. In
general, the more decentralised we make a system, the more trusted it will Limitations

Despite the potential advantages of blockchain, the Committee also received evidence
describing a number of limitations.
22. In written evidence, the Bank of England noted that scalability and reliability of
blockchain was a significant challenge, and that such technology “will need to prove it can
reach the performance standards of more conventional technologies.”25 Mr Taylor from
Everledger told the Committee that blockchain is not automatically more reliable than
other databases, and “is the same as any system. It is garbage in, garbage out. 

You have to
make sure that the participants that you are allowing to contribute on to the network are
23. The Bank of England also noted that further “consideration will be needed around
how a distributed system is controlled and governed.”27 Martin Walker, a Director at the
Centre for Evidence Based Management, shared this view, arguing that a decentralised
blockchain may raise risks that no one is accountable for:
The difference when people talk about decentralised, which is where the big
regulatory red flag comes up, is no one is accountable.

 That is a very serious
problem, in terms of consumer protection and law enforcement, but also if
you are linking the existing world financial system into something that is
generally decentralised, where no one is in control.28
Jorge Stolfi, Professor of Computer Science at the State University of Campinas in Brazil,
noted in written evidence that the absence of a central authority can mean blockchain
users remain anonymous, as there is no-one to confirm their identities.

 This “relative
anonymity”, he argued, made blockchain useful as a means of facilitating illegal activity.29
Blockchain as a payments system, and crypto assets as a medium of
24. The original purpose of blockchain and Bitcoin was to create an alternative system
of payment. Satoshi Nakamoto, the founder of Bitcoin, intended it to be “a purely peer-topeer version of electronic cash [that] would allow online payments to be sent directly from
one party to another without going through a financial institution.”30
25. In his speech on The Future of Money, the Governor of the Bank of England,
explained that “in the depths of the global financial crisis, the coincidence of technological
developments and collapsing confidence in some banking systems sparked the
cryptocurrency revolution.”31 The peer-to-peer nature of blockchain enables individuals
to transact without going through a financial intermediary in the traditional financial   system. Transacting with crypto-assets also means that there is no reliance on a central
bank issued fiat currency.32 Advocates claim that transacting through crypto-assets
is more trustworthy than centralised fiat money as crypto-assets are “immune from
[…] debasement [and] its use is free from risky private banks.”33 Marco Santori, Chief
Legal Officer and President of Blockchain,34 explained that for some people blockchain
represents an alternative way of transacting and living:
People do not come to Blockchain just to speculate, or to try to buy
something for a dollar and sell it for two. They come to Blockchain so they
can live and so they can escape Governments that have been irresponsible
with their currencies. They can prevent their hard-earned savings from
being nationalised. They do it so they can transact in a way that does not
rely on an intermediary that charges them a hefty fee.35
26. Obi Nwosu, Chief Executive Officer of Coinfloor,36 explained to the Committee that
payments using crypto-assets rather than traditional currency could further financial
inclusion for individuals who do not have a bank account:
With cryptocurrency, maybe it is not as good as a depository bank account
but it is better than nothing at all if they want to buy something online.37
[…] Governments around the world, and especially the western world, have
policies around improving financial inclusion. Cryptocurrency could be an
alternative or a mechanism in achieving that.38
27. While crypto-assets may provide a potential payment service solution for people
without bank accounts, users would still have to acquire crypto-assets with conventional
currency, which generally requires access to banking services. When asked how this
problem could be overcome, Mr Nwosu told the Committee:
Instead of asking for payment [of wages] in a fiat currency, I ask for payment
in cryptocurrency. That is the simplest way.39 […] In places where people
are unbanked, instead of accepting currency in cash, they may say, ‘I want
to buy something online; I will accept currency in crypto for whatever task
I do’, whether it is giving you some water, washing your car or whatever it
may be. They use that cryptocurrency to purchase something online.40
28. Izabella Kaminska, Editor of the Financial Times Alphaville, was sceptical of cryptoassets being a “panacea”41 for financial exclusion. She said “we should not confuse financial
inclusion as a technical problem. It is very much a socioeconomic problem.

29. Finally, some argue that crypto-assets could be more efficient that centralised fiat
money because “the underlying [blockchain] cuts out intermediaries like central banks
and financial institutions and allows payments to be made directly between payer and
payee.”43 However, the efficiency of blockchain and crypto-assets is disputed, as set out
30. As discussed in Chapter 1, blockchain is not being widely used as a payments system,
and crypto-assets are not being used as a medium of exchange, because they are currently
failing to perform the three key functions of money: as a store of value, a means of payment
and a unit of account.
31. In its written evidence to the Committee, the Bank of England noted that cryptoassets are too volatile to be a credible store of value:
Measured against the US dollar, Bitcoin is ten times more volatile than
sterling, and other cryptocurrencies are even more volatile. If contracts
were specified in cryptocurrencies, the value received in payment may be
significantly less (or more) than the value at the time of the agreement.
Retailers accepting payment in crypto-assets would have to take significant
exchange rate risk whilst holding the crypto-asset.44
32. In the Bank of England’s Quarterly Bulletin article titled The economics of digital
currencies, the Bank of England explained that “most existing [crypto-assets] incorporate
strict rules that govern their creation, following a pre-determined path to a fixed eventual
total supply.”45 For example for Bitcoin, the “system’s protocol dictates that there will be
an eventual total of 21 million, which should be largely reached by around 2040.”46 David
Gerrard, author of Attack of the 50 Foot Blockchain, argued that the limitation on the
supply of Bitcoins meant that deflation was an explicit design feature.47 He noted that
“Nakamoto [the pseudonymous creator of Bitcoin] put forward as a positive for Bitcoin
that it would go up in price, with greater demand and use.”48 However, he argued that this
“disincentivis[ed] its use of a currency; if your money is worth more tomorrow, you won’t
spend it today.”49
33. The Bank of England argued that crypto-assets and blockchain “do not function
well as a means of payment.”50 Firstly, crypto-assets and the underlying blockchain face
capacity constraints:
[Blockchain] cannot handle the payment volumes required. Every day in
the UK, more than 30 million electronic payments are made through Bacs
and Faster Payments [payment systems]. In contrast, Bitcoin’s global peak
capacity is around 0.6 million transactions per day

34. The Bank of England also explained that capacity constraints lead to higher costs for
transactions made through blockchain crypto-assets:
When demand for crypto-asset payments exceeds the capacity of the
network, users must offer fees to ensure that their transaction is at the front
of the queue of payments. In December 2017, when demand for the Bitcoin
was highest, average fees peaked at nearly $60 per transaction whilst tens of
thousands of lower-fee transactions sat pending for hours at a time.52
35. A blockchain’s fundamental requirement for transactions to be verified by participants
also limits the speed at which transactions can be verified:
Cash and contactless card payments can be confirmed instantly. In contrast,
transactions on crypto-asset platforms are only “confirmed” when they have
been included in a block of transactions that is written to the ledger. For
Bitcoin, it takes an average of 10 minutes to receive the first confirmation.
As good practice and for higher value sales, sellers are advised to wait for
six confirmations (around 60 minutes) before considering the payment to
be irreversible. This is impractical for most physical retailers.53
36. The verification required of blockchain transactions requires large amounts of
computer power and, correspondingly, energy. Mr Gerrard argued that:
The problem is that decentralised systems are vastly less efficient that
centrally controlled ones. This is reflected in the […] waste of power
involved in Bitcoin’s “proof-of-work” […] system, where it uses 0.1 per cent
of the world’s total electricity consumption, or an amount comparable to
the entire Republic of Ireland.54
Such energy costs need to be paid for, and the Bank of England explained that these high
energy costs will lead to higher transactions costs:
If crypto-assets were to replace traditional currencies, the use of proofof-work would make crypto-assets inherently more energy intensive per
transaction than conventional payment systems and imply a higher cost
per transaction.55
Application of blockchain to financial services and other industries
37. Throughout the course of the inquiry, the Committee received evidence on how the
blockchain has been adapted to serve a wider range of purposes. The Bank of England
stated that:
It is useful draw a clear distinction between […] the underlying
technology powering the majority of crypto-assets on the form of public or
‘permission-less’ distributed ledgers, and the significantly adapted versions
of [blockchain] that are being developed for use in financial services on
private or “permissioned” distributed ledgers.

Financial services
38. The Bank of England explained that the “distributed ledger technology arrangements
being explored in financial services are generally ‘permissioned’ i.e. participants require
permission to participate in the network, and its underlying distributed ledger is private.”57
For example, R3, an enterprise software firm working within the financial services sector,
is developing a platform called Corda “[to enable selected] institutions to transact directly
[with each other] using smart contracts58.”59 Ms Kaminska and Mr Walker also cited
other examples of the deployment of blockchain in capital markets, including “Digital
Asset Holdings’ and the Depository Trust and Clearing Corporation’s work on repos;
Digital Asset Holdings’ project to replace the back-office system of the Australian Stock
Exchange; and Axoni’s work on equity swaps.”60
39. In their written evidence to the Committee, Ms Kaminska and Mr Walker
acknowledged that “a very wide range of claims have been made […] about the potential
benefits of applying blockchain […] technologies in the financial services sector.”61
However, they argued that in most cases, “how blockchain [would] specifically solve
problems or generally make things better [is] not explained.”62
40. In discussing examples of the wider application of blockchain to the financial services
sector, Ms Kaminska and Mr Walker noted that many of these do not deploy cryptoassets, restrict the number of participants on the ledger and have “a central body […]
responsible for maintenance of the ledger and […] granting access to it.”63 They added
that, in many cases, these examples were “so different from the original blockchain, it
becomes meaningless to refer to it as blockchain.”

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