Three Fatal Blockchain Myths

Cryptocurrencies and their underlying technology – the blockchain – have inspired media and pundits alike.

The technological setup is rather complex, and the average reader, as well as many crypto-lovers, may not be familiar with the financial terminology and payment infrastructure.

All of this is fertile ground for a number of tenacious myths that have underpinned most blockchain discussions. These myths are either wrong or too simplistic and, thus, cloud the judgement of decision makers.

I will dismantle three intertwined assumptions that jointly fuel the argument that blockchain technology will break banks.

Myth 1: "Open blockchains rather than closed will power tomorrow's economy"

Behind the initial propagation of blockchain technology was a group of people united by the excitement about getting rid of banks. Especially in the wake of the financial crisis – bitcoin was invented in 2008 – their followership grew exponentially. The technological setup of bitcoin and its decentralized nature represented the antidote to a financial system run by big financial players. Yet time showed that decentralization is not a necessity for a blockchain.

Very broadly speaking, there are two major blockchain-setups:

Every blockchain system is distributed, meaning that there is no middleman that maintains a ledger, but rather a system of multiple nodes. Decentralized ("open") chains mean that no node is privileged over the others by the algorithm. On the other hand, centralized ("closed") chains can give some nodes more weight than others.

Bitcoin is a decentralized blockchain where everybody can participate in verifying transactions and each node carries the same heft.

However, the distinction is not always so clear-cut. The degree of centralization in Ripple, one of the three largest crypto-coins, is still a matter of debate within the industry. So is its status as a blockchain, because transactions are not bundled together into a block, but rather resemble a big ledger. Why does this distinction matter?

The original, decentralized model has many shortcomings. The energy-consumption is unsustainable, the necessary scale unreachable, the usability a pain, and regulation a thing to be bypassed by design. Financial transactions also take far too long. Add to that the currency problems crypto-coins face and you can understand the scepticism of many incumbents. Centralized blockchains can remedy all these weaknesses and are already the model of choice for most financial institutions engaging in blockchain.

So why then the hype around open blockchains? This technological controversy is symptomatic of a deep ideological rift at the centre of the blockchain debate. In one corner are the incumbents of the banking and payments world, in the other an unusual alliance of crypto-evangelists, anarcho-libertarians, entrepreneurs, and fraudsters who are set for disruption. The latter group represents the founders and early adopters of the blockchain and still carries significant weight in shaping public debate about it. They see in blockchain the means to bring down any kind of trusted institution and in their view, this can only happen with truly decentralized applications.

Myth 2: "With the success of the blockchain comes the downfall of banks"

Given the background of the early crypto-enthusiasts, it is perhaps unsurprising that banks are proclaimed to be the first victims of the blockchain.

As shown above, however, the winning model will be one with at least some kind of centralization. This already cries out for a broker of trust, meaning that banks will be part of the equation. And even with a totally decentralized algorithm, there need to be institutions that manage data and access rights before or after a transaction. Even bitcoins need institutions such as exchanges where you can buy and sell them.

Payments are just one part of the banks’ value chain. Even if cryptocurrencies managed to supplant banks from moving value, they could not replace them in providing a permanent and stable storage of value. Neither could the provisioning of loans work without financial institutions. Rather than the blockchain breaking banks, banks can break into new markets using it to embrace the digital paradigm.

Myth 3: "FinTechs are the banks' main challenge"

This third myth seamlessly blends in with the first two. Decentralization, contrary to the very nature of banks, lays the groundwork for their fall and ergo there also needs to be a pristine challenger who pushes them from their throne.

This role falls to the young and agile FinTechs. They start with a clean slate and can devote their entire energy to new products. Dynamic FinTechs have the flexibility to follow with ease any direction the market takes. We have seen it happen to retail and hardware-manufacturing, so why not finance?

Truth is, these examples are so prominent because they are the exception rather than the rule. Studies show that where an industry structure is jumbled, this happens not by greenfield competition, but in the overwhelming majority of cases either by the incumbents or by market entrants dominant in other industries. As a rule, new entrants lack the scale, the financial muscle, and the brand awareness. Usually, it takes longer to build those up than to steer incumbent supertankers into the winning direction. I have discussed here what this means for banking, namely that data behemoths are much better positioned to cut into banks’ profits than FinTechs.

One example often quoted to show banking is not immune to innovation is Paypal. Unlike Visa or Mastercard, it is no product of banking collaboration, yet it has already become the largest online payment method in North America and covers over 354 billion USD in payment volume globally. It has over 200 million active user accounts. But Paypal wraps itself around the currently existing system. It does not supersede credit cards or bank accounts but supplements them. Blockchain start-ups are a completely different story. Banks have long realized that the technology will help them to save a lot of money in the back-end. Countless initiatives, acquisitions, and blockchain labs are a testament to this [link here to the other article I send]. They will not be caught napping again.

And finally, one crucial question remains: Do FinTechs really want to displace the current incumbents? Most mission statements for sure read as if this is the goal, yet in a study, 75.5% of all FinTechs declare that partnering with an established firm is their primary objective. One reason might be that already now many blockchain start-ups are fuelled by incumbent capital, such as Veem that pocketed $25 million from an alliance led by Goldman Sachs. Disruptive to the way we do finance they are, but disruptive to the competitive landscape not so much.

The persistence of these three myths has for sure nourished the interest in blockchain technology. They are simple, speak to an engaged target group, and can be supported with carefully selected, eye-catching examples. Believing them uncritically, however, might cost you real money - whether you are considering buying a crypto-coin or whether as a corporate decision maker you ponder to invest in new infrastructure.

Due to its multitude of mechanisms and the resulting fuzziness, blockchain technology is surrounded by even more misconceptions. To have a long-term strategy for blockchain that will not be steered by the latest news items, it is incumbent to clear those up.