Commentary: Behind the cryptocurrency mania, the secret sauce is Bitcoin’s blockchain technology

SINGAPORE: The furore over the future of cryptocurrencies such as Bitcoin has reached ever more frenzied peaks since the start of the year.

Goldman Sachs recently predicted that most cryptocurrencies will inevitably crash to zero and the head of the World Bank has warned that most resemble Ponzi schemes.

Meanwhile internet entrepreneurs turned venture capitalists the Winklevoss twins have said they expect Bitcoin to soar to 40 times its current value.

But such feverish debate over valuations of cryptocurrencies like Bitcoin has obscured the real story: That blockchain – the underlying technology behind Bitcoin and other cryptocurrencies – is poised to revolutionise the way the world does business in much the same way email and the internet did.

But the trouble is there hasn’t been a high-profile use case that has shown how blockchain can fundamentally alter the way companies do business or touch a facet of life the man on the street can relate to.

THE POWER OF BLOCKCHAIN

The innovative power of blockchain is that it creates a platform allowing any two parties to digitally transact with each other using an immutable, continuously-updated, distributed ledger.

In the case of Bitcoin, with no central authority overseeing the system, the task of updating the ledger relies on miners (“competitive bookkeepers”) who verify transactions and get rewarded with Bitcoins.

On average, a new block on a blockchain gets verified every 10 minutes and carries a reward of 12.5 newly created Bitcoins as a form of incentive. The entire supply of Bitcoins – which will peak at 21 million in 2140 – is pre-programmed by Bitcoin’s original developers.

Just as the invention of the underlying technology behind email enabled the transfer of information from one user to another, blockchain enables the transfer of value from one user to another without the need for an intermediary like a bank.

This has huge implications for traditional intermediaries such as auditors, lawyers or public notaries, and without radical transformation, entire industries face a very real existential threat.

For example, most e-commerce currently relies almost exclusively on third parties such as Visa or PayPal to process electronic payments, charging transaction fees of up to 5 per cent. Overseas money transfer firms like Western Union and MoneyGram charge even more – often over 10 per cent.

These industries seem ripe for disruption and with the growth of blockchain the fate of financial remittance companies may resemble the demise of travel agents in the 1990s.

At a national level meanwhile, a growing number of countries are exploring how to put their currencies on blockchain. 

For example, the Monetary Authority of Singapore (MAS) recently partnered with a consortium of banks to develop Project Ubin, a pilot tokenised version of the Singapore dollar that replicated the existing financial payment system without a centralised clearing system.

It is now working on similar projects focused on fixed income securities trading and cross border payments.

It seems that certain banking functions, for instance payments and cross-border transactions may be put on a blockchain going forward, reducing infrastructure costs while enhancing transparency, traceability and security in the financial services sector.

But blockchain technology has applications well beyond the finance industry.

Indeed a recent Harvard Business Review article said blockchain “could change the very nature of economic, social, and political systems.” The article’s authors, both Harvard professors, said they foresee a world where “every agreement, every process, every task, and every payment would have a digital record and signature that could be identified, validated, stored and shared”.

By allowing businesses to control their own data, ensuring immutability and transparency, it offers transformational potential in areas such as inventory control, food safety and record management, including medical records.

In January, IBM and Danish shipping giant Maersk announced a joint venture to use blockchain in shipping supply chain. In a sector which handles around U$4 trillion of goods per year, the firms said they expected savings of up to 15 per cent of this amount, mostly by eliminating the bureaucracy and corruption risk in manual procedures.

Another area where blockchain shows significant promise is food safety.

Recently Walmart launched a pilot in China using blockchain to track and trace shipments of pork. Making food supply chains transparent and traceable brings a range of potential benefits – for example, while it normally takes days to recall a food product, blockchain can do it in seconds.

MINING INVOLVES A LOT OF ELECTRICITY

Before we become swept up in the excitement, it’s important to also bear in mind the challenges.

One often underreported downside of blockchain is the power consumption it accounts for. Mining Bitcoin alone, for example, has been estimated to account for 42 terawatt-hours per year – similar to the annual consumption of Hong Kong or New Zealand. This may potentially be alleviated by different mining processes, but these will likely raise different issues and challenges.

Another critical issue is security. Bitcoin is safe as long as honest nodes control more power than potential collaborating attackers. However, this can be undermined by the formation of mining syndicates since collusion among groups with more than 50 per cent of mining power could enable hacking of the system.

Scalability likewise needs to be urgently addressed as the reach and use of cryptocurrencies continue to grow. Bitcoin, for example, can currently only process roughly seven transactions per second whereas in contrast Visa can process more than 50,000 per second.

The most critical risk however comes from regulatory bodies and the response they take to this growing phenomenon.

Several governments including Bangladesh, Nepal and Vietnam have banned Bitcoin transactions outright. China and South Korea meanwhile have recently introduced strong regulatory measures such as restricting trading in cryptocurrencies.

Others like Hong Kong and Singapore have adopted a more measured approach – Singapore’s MAS announced that while it had no plans to regulate cryptocurrencies, it would come down hard on any money laundering and terrorist financing risks.

Perhaps one particularly significant sign came in recent testimony to a US Senate by J Christopher Giancarlo, Chairman of Commodity Futures Trading Commission.

His view, he told the panel, was that “distributed ledgers have the potential to enhance economic efficiency, mitigate centralised systemic risk, defend against fraudulent activity and improve data quality and governance.” As such, he added, the right regulatory approach to blockchain technology would be to “do no harm”.

This statement may go down as the moment that blockchain entered the mainstream.

Just like how people didn’t foresee the impact of e-commerce before Amazon arrived or that of social media before Facebook, it’s conceivable that blockchain may become the next big tech.

In fact, blockchain may have the potential to underwrite the very systems we depend on today for any sort of transaction.

So what does this mean for those investing in cryptocurrencies? Given their wild swings in price, the highly speculative environment and lack of pricing models, investing in specific cryptocurrencies such as Bitcoin or Ether remains a highly risky prospect for the vast majority of retail investors.

However, for a lot of businesses, investing in blockchain may be a prudent strategic investment.

Indeed, as the technology’s potential continues to grow, we will see the emergence of innovative companies with creative and disruptive applications that existing firms and industries cannot afford to ignore.

Emir Hrnjic is a visiting senior research fellow at the Centre for Asset Management and Research Investment at the National University of Singapore (NUS) Business School.