On the potential of closed-system blockchains
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MARCH 19, 2015 By: Izabella Kaminska
Followers of FT Alphaville’s Bitcoinmania series will be familiar with our generally sceptical position on all things bitcoin.

Indeed, over the course of more than 64 posts, we’ve presented a mostly negative case for bitcoin “the currency”, and remain confident that the open-source “people-cleared” cryptocurrency (which replaces one accountable and identifiable third party with 10,000 anonymous parties of dubious intent) is ill-suited for the job of currency in any stable economic system.

That said, we have reflected tiny bursts of enthusiasm for what blockchain technology, the distributed public ledger underpinning bitcoin, could do for the murky and shadowy world of OTC bilateral clearing.

Such enthusiasm should not, however, be confused with the current industry vogue of rubbishing bitcoin whilst simultaneously claiming that the blockchain technology is genius.

We are less sanguine on the latter front.

For one, we’re not convinced blockchain can ever be successfully delinked from a coupon or token pay-off component without compromising the security of the system. Second, we’re not convinced the economics of blockchain work out for anything but a few high-intensity use cases. Third, blockchain is always going to be more expensive than a central clearer because a multiple of agents have to do the processing job rather than just one, which makes it a premium clearing service — especially if delinked from an equity coupon — not a cheaper one.

In short, the cost structures have not yet been proven. It’s all very enticing using blockchain to clear your financial positions as long as the service remains cheap as chips — (largely because it’s being subsidised by investment flows or an altruistic network of computer processors). Not so much, however, if the costs start rising because the network wants compensation for its efforts.

Until they do, however, what’s not to like if you’re Blythe Masters? You’ve just found a genius way of passing on your clearing costs to a network of unsuspecting volunteers and speculators. Even better than that, they don’t seem to notice the huge favour they’re doing for big financial businesses, perhaps because they’ve become so distracted by the idea of not depending on banks they’ve overlooked that in the process they’ve become poorly paid bank employees instead?

If blockchain is to make an impact in any sphere it must be in a non exploitative and cost transparent way. Call it a raison d’etre participation structure, where nodes are incentivised to fund or work for the system because they themselves benefit from the services being cleared.

A good analogy is a baby sitting collective where the participants have an incentive to provide quality work to the system because they themselves want to redeem similar work from others in the system. They are all in the scheme to benefit from the services, not just to make money. What they put into the system is what they get out. And they have no incentive to put in any more or less than than they plan to redeem in kind.

Were the baby sitting collective, however, to be opened to non-beneficiaries, those who baby-sit solely for the purpose of accumulating credits would have an incentive to resell them to the highest bidder in an open market. This would expose the collective to centralisation and corporatisation. Before the participants knew it the collective itself would be dead and a centralised babysitting corporate would be dominating the system.

The same dynamics, we believe, apply to blockchain. For it to work, a raison d’etre closed structure where participants get repaid in kind not in profit is needed.

We’re about to moderate a panel on Thursday at Consult Hyperion’s Tomorrow’s Transactions forum, where we plan to dive deep into some of these issues. We’re open to persuasion.

We’ll be back with some insights from the likes of Richard Brown at IBM, Douwe Lycklama from Innopay, Preston Byrne, Eris Industries and Vitalik Buterin from Ethereum.

Consider this a curtain raiser.