Crypto craze stunts growth of underlying blockchain technology

Bitcoin, and cryptocurrencies generally, are harming the development of productive applications of blockchain technology. The time has come to move past the fantasy of cryptocurrency riches and to productive uses of this technology.

One expert recently suggested as much, stating that “skepticism about the value of blockchain may be rooted in unease about its connection to bitcoin and other virtual currencies known as cryptocurrencies.”

{mosads}The Society for Worldwide Interbank Financial Telecommunication (SWIFT), which handles more than half of all high-value, cross-border payments, concluded “that the technology is not ready for mainstream use,” after recently testing the blockchain technology.

SWIFT added that “further progress is needed … before [blockchain] will be ready to support production-grade applications in large-scale, mission-critical global infrastructures.”

The “get rich quick” scheming of cryptocurrency promoters has exacerbated the skepticism about blockchain technology, also known as distributed ledger technology (DLT). 

That focus on cryptocurrencies has diverted attention from what DLT actually is and its potential once certain practical limitations of DLT have been overcome. That potential includes minimizing fraud, ensuring data accuracy, speeding up transactions and reducing the cost of running a DLT system.

While cryptocurrencies rely on blockchain technology to minimize fraud, it is fraud, in fact, in the form of numerous thefts of cryptocurrencies, that is a serious, ongoing problem.

Presumably, cryptocurrency fraud is prevented, or at least minimized, by multiple independent parties processing the same transaction in parallel; that is, by each party adding a new transaction to an existing set, or “block” of transactions. 

The creation and maintenance of these independent records — a chain of title — make it impossible to later alter that chain of title through a subsequent manipulation of transaction data in the several independent DLT databases.

However, cryptocurrency fraud occurs in the exchanges where electronic wallets holding cryptocurrencies that have been purchased on the exchange are subsequently pilfered through computer hacks. Recovering this stolen property has proven to be very challenging.

The literal application of blockchain technology – the addition of a new transaction to a group or block of previous transactions affecting a discrete item and the encryption and multiple replications of the just-updated block – does not protect against the entering of erroneous data into the block, rendering it worthless. 

No amount of subsequent data replication or blockchain consensus will correct that problem – it can be fixed only by entering a correcting transaction.

The pursuit of accuracy strongly suggests a central authority or governing body must oversee a specific application of DLT in a “permissioned” environment, with pre-agreed rules and procedures to ensure the accurate entry of transaction data into the DTL ledger, the prompt correction of data-entry errors and overall data integrity. 

Only those who agree to play by the rules established for the DLT shall be authorized to enter data into and/or access the database overseen by that governing authority.

Replicating blocks of data through independent processors — the mining process for many cryptocurrencies – to ensure accurate processing of transactions in the database has rapidly diminishing value as the number of replications increases. 

More specifically, it is highly unlikely that the third, fourth or fifth replication of the entry of a new transaction will reveal processing errors or fraudulent data that the first or second replication did not catch, yet each additional replication and consensus check possibly slows the processing of individual transactions while adding cost.

It is hard to imagine why more than two or three replications of transaction data by the computers processing those transactions on geographically dispersed ledgers is necessary to ensure 100 percent transaction accuracy.

A real-world application of DLT will occur only if it makes economic sense. An application that minimizes the potential for fraud, is highly accurate and very fast in executing transactions will not be implemented if it is more costly to operate than an alternative, less sophisticated technology.

One unfortunate aspect of cryptocurrencies is that the substantial cost of keeping a cryptocurrency operational, through the highly repetitive processing of cryptocurrency transactions, is not readily evident. 

Those costs — electricity, computer chips and other hardware and high-skilled labor — are masked by the creation of additional cryptocurrency coins that cryptocurrency “miners” earn by processing the transactions of a particular cryptocurrency. They then sell those coins to cover their costs and earn a profit. These miners are gambling every day that the coins they earn will at least cover their costs.

Recent news articles have drawn attention to the enormous amount of electricity the crypto miners use, with negative environmental consequences, their intense demand for computer-processing chips, and even their possible drag on American productivity.

The ongoing decline in cryptocurrency prices, coupled with the increased resource consumption for each additional coin that is created, raises this question: How much longer will the cryptocurrency gamble continue to pay off for crypto miners?

This question suggests that viable, long-term applications of DLT cannot depend upon an ever-appreciating price of an ethereal “currency” that has no intrinsic value and only very limited utility as an actual currency.

This conclusion argues that successful applications of DLT will be no different than for any other business process – they will have to generate sufficient revenue, in the form of transaction fees, to cover all their costs, including an adequate return on the capital invested in the DLT infrastructure.

Key to developing profitably applications of DLT will be reducing the cost of processing transactions, which means optimizing the degree of repetitive, energy intensive processing of individual DLT transactions.

Given how costly many financial and property transactions are today that are potential applications of DLT, such as cross-border money transfers and the recording of property transfers, there should be numerous potential, profitable applications of DLT. But as SWIFT has observed, “further progress is needed” before profitable applications of DLT emerge. 

Shifting the world’s focus away from the false promises of cryptocurrency wealth and to economically sound applications of DLT will deliver the potential that DLT has to offer. That cannot happen soon enough.

Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system and the growing federalization of credit risk. Prior articles by Ely on cryptocurrencies can be found here.