Today I got this question on Wiselike, a personal Ask-Me-Anything (AMA) website a la Reddit’s, and I thought it was worth turning into a blog post. Here we go.
There is a stigma attached to Bitcoin fuelled by sensationalism. Volatility, Silk Road, Mt Gox, ISIS using Bitcoin and other damaging events or fabrications (Europol just confirmed there is no proof of ISIS using Bitcoin) has hurt Bitcoin’s brand. At the same time financial institutions discovered the potential of the technology underpinning Bitcoin called the blockchain, whereas companies trying to position themselves towards these financial institutions took the chance to disassociate themselves from Bitcoin. And so the narrative was born that fit these company’s incentives and FI’s agenda. This is not to say that there is no merit to the distinction, rather it is an observation of how the narrative evolved from Bitcoin is bad to Blockchain is good. Some did so for valid reasons, others for aesthetic reasons as they continued to use Bitcoin’s blockchain.
When you do a deep dive with the financial crime and anti-money laundering departments of large financial institutions it boils down to traceability, reversibility, privacy and mining rewards.
The flow of money in the digital economy can be traced back to an identity. Either directly or through subpoenas. And it’s becoming increasingly difficultto hide your funds. Contrast to today’s digital money, it is easier to hide an identity using Bitcoin through the use of mixers, HD wallets and other type of trace-obfuscating means. However, as digital cash Bitcoin is more traceable than regular cash. It is also worth noting that we are seeing the emergence of forensic tools like Chainalysis and Coinalytics that reveal the transactional flow of the Bitcoin blockchain in detail, identifying an increasing amount of Bitcoin addresses over time. The counter-movement to this are cryptocurrencies that create new ways of obfuscating the identity, like Dash, which could be seen as a Tor for cryptocurrency.
Bitcoin has no chargeback capabilities, although recently core developers introduced something that may function in a similar fashion. That is until the Bitcoin network confirms the transaction, unlike regular chargebacks that can retrospectively be executed. More info about this here by Bitcoin Improvement Proposal (BIP) developer Kalle Rosenbaum:http://popeller.io/index.php/2015/12/21/sorting-out-replace-by-fee/
Financial institutions are required to protect transactional data. The problem with the Bitcoin blockchain is that all transactions are broadcasted to the entire network. HD wallets can obfuscate this somewhat by generating a new bitcoin address for every transaction, but as mentioned above, sophisticated forensic tools are becoming available that may compromise the identity through association.
One of the more difficult debates revolves around the question whether a financial institution is allowed to pay a mining fee to an anonymous entity or person. As far as I’ve been told (sold) this could theoretically be circumvented if financial institutions would run their own nodes / mining farms. Or at least this solution would have a high probability of paying the fees to themselves, approximately 99%* was mentioned to me. What implications this may have to their block security and accuracy is a question I have yet not received an answer to.
*Any experts that may want to weigh in here, please do.
In any market there are commercial reasons that influence the narrative. I’ve highlighted two key stakeholders.
Financial institutions (FI)
Bitcoin as an open source monetary system and payment rails is harder to monetise with traditional business models and as showcased by the current consensus efforts, impossible to control. Therefor it threatens the compliance and monetary oligopoly of the finance industry. Blockchain on the other hand poses an opportunity for improved efficiency to potentially fend off the fintech disruption of the finance industry. So logically and naturally FI’s are exploring the potential of alternative blockchains.
Bitcoin as a deflationary cryptocurrency — it is inflationary up until the 21 million cap, but with growing adoption effectively already gaining spending power per coin — goes against the grain of fiat money and the ability to influence the economy through monetary policy. Losing this ability renders central banks redundant. Digital currency on the other hand as represented by blockchain in the form of private or shared ledgers with cryptocurrency, pose an opportunity for central banks to issue their own digital cash. This is in line with their objective to move towards a cashless society and has the added benefit of superior traceability compared to cash.
That leaves us with the technological arguments and there are many. Broadly speaking they centre around scalability, security and functionality.
This relates to the non-functional requirements like the transactions per second and reliability of the network. For instance, Bitcoin’s current block size debate aims to resolve the issue that limits the amount of transactions that can be processed in a block (Bitcoin Classic vs Bitcoin Core / Lightning Network), whereas other blockchains are built to scale from day one. This also touches upon the functionality of the protocol (see below) as the myriad of use cases require different non-functional requirements.
Looking at decentralised cryptocurrencies using the Proof-of-Workmethodology to secure the network, there is nothing that beats the mining power that secures the Bitcoin blockchain. However, blockchain companies have introduced different ways of securing the network through Proof-of-Stake or for instance by relying on trusted nodes. In this debate it matters whether the objective is to keep the network decentralised or not. Blockchain companies often gravitate towards centralisation as this is easier to control and as described above, control is commercially important for certain stakeholders.
This relates to the multi-purpose potential of Bitcoin’s blockchain where some companies have focused on one of its use cases. In other words, Bitcoin is a currency, a payment network and a protocol to trade assets. It is however not optimised for all of these use cases and the question arises whether Bitcoin should be modified to accommodate them better (BIP) or that it should rely on technologies that are built around it (Blockstream, Open Assets Protocol, Strawpay and others) or if it requires completely new blockchains that are operating independently of Bitcoin’s blockchain (Ripple, Ethereum and others). The jury is still out on this.
It is important to remember that cryptocurrencies are a bottom-up movement whereas Blockchain efforts are *primarily top-down implementations. This doesn’t mean that there will only be one winner, neither can we declare Bitcoin’s defeat, or similar decentralised cryptocurrencies like it, just because the current legal framework creates obstacles for adoption. Time will tell as analogies are plentiful and inconclusive.
*Although blockchain protocols exist that are bottom-up inventions, the leading Blockchain players in the market today focus on top-down implementations, i.e. financial institutions. Examples: R3CEV, Ripple, Hyperledger, Chain. Ethereum could be considered an exception to this as it appeals to both audiences.