Blockchain - Is this the end of the (banking) world as we know it?
Guest contribution published in the Handelsblatt on 26.04.2016
Are banks soon to become superfluous and be replaced by super-efficient computers? In an increasingly interconnected world with extremely powerful computers, this is the question facing the financial sector - an industry which is currently being completely transformed by the wave of digitalisation. "Blockchain" is a prime example of this. Virtually no other financial technology has fuelled the discussion about the possible end of the banking world in the same way as blockchain has. The vision of blockchain's advocates is to enable financial interactions without the involvement of central intermediaries.
Strictly speaking, this innovation consists of two autonomous inventions, which, however, are generally considered as a single system. For one thing, in a blockchain, the current transactions are linked to the chain of all the previous transactions. This means that the transaction history is fully traceable by all participants in the network. For another, "distributed ledgers" enable this blockchain and its transactions to be simultaneously documented and reconciled in a decentralised network of computers. Blockchain is therefore a consensus-based system. As a result, financial transactions could - or so it is claimed - be documented in a tamper-proof and irrevocable manner. Furthermore, the parties involved would no longer have to wait a day (or longer) for the transactions to be settled, as this occurs immediately.
This new technology could, therefore, revolutionise not only IT infrastructures but also stock exchange trading or certain financial contracts. The administrative burden and the time spent reconciling transactions would be dramatically reduced as a result. It is therefore not uncommon to hear predicted savings of tens of billions of euros in the banking sector alone resulting from the use of blockchain. And of course, blockchain could also compete with the existing systems run by credit institutions and market infrastructures. Trust in the smooth settlement of transactions and in the sound administration of contractual relations is currently still ensured by a wide range of entities both inside and outside of credit institutions.
But is that necessary? Some visionaries are already fundamentally calling into question whether credit institutions are really necessary, especially as trust can equally be achieved through technical processes. This question is also of interest with regard to banking supervision. After all, the prototype of blockchain was established as a digital payment system using bitcoins as a digital currency - a system which functions without the involvement of central intermediaries or a central bank. A decentralised bookkeeping system of this kind, which is solely dependent on unchanging rules and consensus within the network, is freeing itself of individual institutions and is even placing itself outside of existing social order frameworks. The user community itself monitors the integrity of the system. Self-regulation takes the place of supervisory authorities and government interventions.
However, a system of this kind is not entirely "free". We are seeing the emergence of the "rule of the code", ie programmers are dominating the network. The question as to how mistakes and errors can be retrospectively deleted from the blockchain is already a legal minefield. Self-governed networks, too, have so far failed to establish legal certainty with regard to the conclusion of a transaction.
What future applications can, however, actually be replaced by blockchain technology and what is just wishful thinking? A study claims that the compute-intensive bookkeeping system behind the bitcoin requires as much electricity as the whole of Ireland. And in its current design, the bitcoin is already facing capacity constraints - even though the number of bitcoin transactions effected today is negligible compared with the total volume of international financial flows. Just to put this into perspective: every day, around 200,000 transactions are settled worldwide using bitcoins, compared with over 60 million credit transfers and direct debits in Germany alone.
However, the real question is not about what is technically possible, but about what is socially desirable. The impression that credit institutions and other financial intermediaries are dispensable is deceptive, as it fails to recognise their essential function. While banks and savings banks require a reliable and trustworthy system for the settlement of payment transactions or for exchange trading, their key contribution is something different. Indeed, credit institutions take on an essential role in managing society's day-to-day risks and are thus an integral part of our monetary system. Moreover, market infrastructures do not always simply perform bookkeeping, but sometimes additionally guarantee the smooth running of operations.
As a result of these risks - and not to protect established institutions - it is justifiable for financial institutions and market infrastructures to be given a special status and, as a consequence, to be made subject to special supervision. As banks and savings banks are subject to financial supervision, they must therefore account for their systems. Even a decentralised network must be able to provide clear information on who, for example, is ultimately liable for the consequences of a programming error. Blockchain cannot therefore serve as a decoupled element of the financial system, but must be an integral part of it.
This of course does not preclude the structure within the financial sector from changing significantly in the future or mean that the number of institutions or market infrastructures is written in stone. This is because blockchain, like other important financial technologies, also presumably has a not inconsiderable impact on what type of value creation will occur in the banking sector in future and where. In practical terms, it is important to ask where the technology actually lowers costs, where it provides greater reliability, actually prevents costly delays and at the same time reliably fulfils regulatory requirements. As new applications can be substantively superior to old systems, the individual banks are forced to tap new potential early on so as not to fall behind the new standards within the industry. Perhaps this explains why credit institutions, above all, are currently exploring blockchain technology so intensively.
One thing needs to be clear, however: the ideas surrounding blockchain and distributed ledger technology are merely initial sketches. Ultimately, blockchain can convert almost all conceivable processes, access rights and the like into program code. Therefore, regulators cannot and should not make blanket judgements about any of the applications, as the crux of the matter can very much lie in individual program lines. An application must therefore continue to fulfil data protection provisions and all security standards. It is also important that the decentralised character of the applications does not prevent individual institutions and system operators from continuing to be held to account.
At the same time, there is also potentially an abundance of possibilities for supervisors of the financial sector. For example, cyber security could be strengthened through decentralised network solutions. Certain supervisory functions could potentially also be technically implemented, while more comprehensive, time-critical analyses could be managed more easily. This also gives supervisors and regulators every reason - if they want to be ahead of the curve - to keep an eye on developments before they reach market maturity.
Financial intermediaries do not define themselves according to their technical resources, but according to the services they provide. Ultimately, even taking blockchain into account, computers, networks and algorithms remain first and foremost tools. It seems reasonable to suppose that, in just a few years, such applications will already be used in areas where large cost advantages and efficiencies are to be expected. However, it is my firm conviction that in our financial system, we will continue to need banks and savings banks that take on risks and - while remaining open to innovation - that can be held accountable when mistakes do occur. None of this can be replaced by a computer program.