When a Blockchain Isn’t a Blockchain

By  for Bloomberg Views

The consulting company Accenture has come up with a way to render the blockchain — the technology behind Bitcoin — more palatable to the world of high finance. The innovation: Make it not a blockchain.

One of the defining features of the blockchain is its immutability. Numerous computers retain identical copies of a permanent, encrypted record of each transaction. Nobody can go back and make changes, so no central authority — neither a government nor a bank — is needed to guarantee the transactions’ legitimacy.

This permanence, though, can be a problem in financial markets. Humans are prone to error, and it would be terrible if such errors could never be amended or undone. Imagine what would have happened in the wake of the 2010 Flash Crash if exchanges hadn’t been able to cancel thousands of erroneous trades.

Enter Richard Lumb, Accenture’s chief executive for financial services, with a prototype for a fully-redactable blockchain. It’sessentially a clone of the Bitcoin protocol, augmented with a trapdoor function that creates a master key to modify or delete any existing entry.

The modification isn’t easy: Remember, the record is maintained on numerous computers around the world. Redactability requires the creation of a governing authority, which instructs all the participants to discard the current blockchain and download a new version from a designated source in the event of an edit. In the case of Bitcoin, downloading an entire blockchain can take days. Accenture proposes to address the issue by “compressing” the blockchain in a way that replaces series of transactions with a computed result. It’s like recording an account balance without storing the full transaction history.

In other words, Accenture has solved the blockchain’s immutability problem by creating a giant, horribly inefficient Excel spreadsheet. Which raises another question: When will financial institutions stop to ask themselves why they need a blockchain at all?

Investment banks have high hopes for the blockchain’s potential to cut costs in clearing and settlement, which involves making sure money and securities get to their new owners after a trade has been made. But a decentralized ledger — again, one of the blockchain’s key features — is always more computationally expensive than a central one. There needs to be a very good reason to have multiple computers replicating the work of one.

Erroneous trades, for their part, are pretty easily dealt with in the current system. Most exchanges have procedures in place forcanceling inadvertent trades. They can do this because they operate in a regulated industry where a central authority ensures the legitimacy of transactions. A blockchain is a place to create protected transactions when they can’t be protected in any other way.

Most of the decision makers in financial institutions don’t understand computer systems, making them easy targets for people peddling blockchains. This is aided by the fact that banks themselves continuously advertise their own blockchain pilots, which often amount to little more than a database upgrade.

Clearing and settlement is a difficult problem that involves the collaboration of many financial institutions as well as industry-wide technology infrastructure upgrades. Finding the right solution might be easier if we stop calling everything a blockchain

First appeared at BV