Blockchain – FINthinkers

The Swiss National Bank and the Cypto Franc

Financial newspaper “Finanz and Witschaft” published an article titled “SNB will keinen Krypto-Franken” reflecting on the speech “The financial markets in changing times – Changes today and tomorrow: the digital future” by Andréa M. Maechler, Member of the Governing Board of the Swiss National Bank (SNB) held at Money Market Event in Zurich on 05th of April 2018.

There are various views on the nature and definition of money, currency and cash which has substantially changed over time. The post How to explain ‘new’ things like bitcoin … provides some thoughts on this topic. It is very difficult to talk about all these terms as the definitions incorporate specific perspectives.

The challenge all countries, including Switzerland, face is to sustain global competitiveness. How does one move from the current economic system, of the industrial age, to one which is digital in its core. The post “Crypto Franc” – key ingredient for a Swiss national blockchain” provides a proposal published by the Fintech Rockers.

This essay proposes to create a Swiss national blockchain. A blockchain allows to track and change ownership of digital assets without the need of a central authority or intermediate. The exchange is peer to peer and cryptographically secured. Money is a key ingredient when values are exchanged and hence a blockchain infrastructure should contain some form of it to unleash the full potential.

“Such blockchain infrastructure, carried jointly by all Swiss cantons, will have an equivalent catalyst effect as the initial introduction of the railway system or the creation of the Gotthard tunnel during the age of industrialization. The Swiss national blockchain will enable local as well as foreign entities and all people with an interest and/or business relation with Switzerland to hold genuine Swiss cryptocurrency and/or execute transactions via legal compliant smart contracts.”

On this blockchain environment a cryptocurrency bound to the Swiss franc controlled by the SNB is envisioned:

“The introduction of Swiss cryptocurrency “Crypto Franc”, bound to the issued fiat Swiss Franc by the Swiss National Bank (SNB), revolutionizing digital payment capabilities. The national blockchain will enable and bring the Swiss industry(s) to the international forefront of the digital age.”

In her speech, Andréa M. Maechler commented on aspects of the proposal:

“A more prominent role for central banks in this end-customer business area is currently a subject of debate, amid calls for ‘digital central bank money for the general public’. The SNB opposes this idea. Digital central bank money for the general public is not necessary to ensure an efficient system for cashless payments. It would deliver few advantages, but would give rise to incalculable risks with regard to financial stability.”

“Which technologies and solutions ultimately prevail on this solid foundation should in principle be left to the market to decide, however. This division of roles between central banks and commercial banks epitomises our current two-tier financial system. It contributes to the stability of the system, while allowing sufficient leeway for innovation.”

Both are for sure valid points – but again perspective matters. If a “Crypto Franc” is seen as a modern form of cash then not a lot would really change. The SNB controls the amount of cash in circulation and it would continue to control the amount of cryptographic cash which could be safely kept and exchanged using a blockchain infrastructure.

Introducing cryptographic cash could have an impact on the financial system as it would allow people to keep their cash safe – within your e-wallet on a blockchain instead of your existing cash account in the bank. With a cash account the client gets a repayment promise by the bank in turn the bank can use the amount from this account for other business (e.g. mainly lending). The value of the repayment promise depends on the trust in the bank while the trust in the Crypto Franc depends on the trust into the currency.

Thus issuing cryptographic cash is not of the interest of the bank when ownership and value is no longer with the bank but with the individuals. Regardless if a cryptographic currency is introduced, the prevalent systemic risk will continue as long as there is still book money or money created though credit. As the adoption of cryptographic currency increases, it will eventually reduce the systemic risks as commercial banks need to compete for such currency of clients. Clients will need to make an explicit decision when putting Crypto Francs onto an account which means transferring ownership to the bank against a repayment promise. They need to assess the risk(s) whether a bank is able to meet its repayment promise. On the other side the bank can provide return on investment where such transparency would rather de-risk the system invalidating some of the arguments stated by the SNB.

There is an increasing interest by companies and other organizations to create their own form of money. Dr. Edward De Bono suggested years back that companies should consider to issue their own currency using IBM as the example (Towards a digital barter economy?). It was futuristic at the time where he made this proposal – but today in a digital world it becomes feasible (David Birch – Before Babylon, Beyond Bitcon – from Money that We understand to Money that understand Us ). There seems to be a trend going into this direction which could accelerate with potential huge implications on the existent monetary system.

“The SNB will keep a close watch on developments to ensure that it always remains able to assess their potential impact on the financial system in good time.”

This sounds given the context to passive. The SNB needs to active in the developments to gain the required experience. Observers will typically be late. Being late means becoming defensive and reactive. The SNB in my view should be active and engaged in building the best possible future for Switzerland and its financial system.

The ‘No’ by the SNB feels premature influenced by past paradigm rather than by the current developments and the needs of the future. One aspect became prevalent from all the statements across the various parties engaged in the thought exchange is the complexity of the topic. It is a complex network problem and requires much more thoughts and discussions. It is key to have these exchanges in a frequent but immediate manner in order to come to conclusions before other organizations/entity(s) may take over and suddenly provide “the” new form of money pushing organizations like the SNB into a reactive rather than proactive position.

“Crypto Franc” – key ingredient for a Swiss national blockchain

In various countries there are discussions about a crypto version of the national fiat currency, which in the case for Switzerland this could be the “Crypto Franc”. We joined the Fintech Rockers writing the exposé Swiss national blockchain and cryptocurrency.

The exposé proposes the “Crypto Franc” in the context of a national blockchain which would serve as the digital backbone in the shaping mesh economy. We expect with a stable currency available on the blockchain that it will provide a catalyst effect of the economy. Such stable currency could be the “Crypto Franc” issues by the SNB directly pegged to the Swiss Franc.

For Switzerland (and other countries) it is imperative to think about its future in a digital mesh economy. Such an envisioned blockchain would be an excellent foundation. There are ongoing debates about such a strategy but prompt and immediate decision and actions on this topic are required in order to stay a leading country in the global financial system.

The exposé was mentioned under the title “E-franc pipe dream fails to arouse Switzerland” on swissinfo.ch recently.

NIST Blockchain Technology Overview

The National Institute of Standards and Technology (NIST) hast published a draft report on blockchain. This report is an excellent summary and overview of the technology, its key characteristics and use cases.

“Blockchains are immutable digital ledger systems implemented in a distributed fashion (i.e., without a central repository) and usually without a central authority. At their most basic level, they enable a community of users to record transactions in a ledger that is public to that community, such that no transaction can be changed once published.”

This has the following implications on organizations:

“However, on a blockchain, it is much more difficult to change data or update the ‘database’ software. Organizations need to understand the extreme difficulty in changing anything that is already on the blockchain, and that changes to the blockchain software may cause forking of the blockchain. Another critical aspect of blockchain technology is how the participants agree that a transaction is valid. This is called “reaching consensus”, and there are many models for doing so, each with positives and negatives for a specific business case.”<

Indeed – this highlights a few foundational aspects – blockchain realizes high data integrity and immutability based on a certain level of transparency required to reach a consensus on the validity of transactions. The report outlines the most important consensus algorithms – each with its drawbacks and advantages.

“In the proof of work model, a user gets the right to publish the next block by solving a computationally intensive puzzle.”
“The proof of stake model is based on the idea that the more stake a user has in the system, the more likely it will want the system to succeed, and the less likely it will want to subvert it.”
“In some blockchain systems there does exist some level of trust between mining nodes. In this case, there is no need for a complicated consensus mechanisms to determine which participant adds the next block to the chain.”

The report also explores the most important types of blockchains :

If anyone can read and write to a blockchain, it is permissionless.
If only particular users can read and write to it, it is permissioned.

The permissioned blockchains are similar to an intranet only visible to the nodes on this network while a permissionless blockchain mimics the characteristics of the Internet.

“The use of blockchain technology is not a silver bullet, and there are issues that must be considered such as how to deal with malicious users, how controls are applied, and the limitations of any blockchain implementation. That said, blockchain technology is an important concept that will be a basis for many new solutions.”

The technology is indeed no silver bullet but is has huge potential for all applications which require a shared agreement and a high level of security.

“Blockchain technologies have the power to disrupt many industries. To avoid missed opportunities and undesirable surprises, organizations should start investigating whether or not a blockchain can help them.”

NIST asks for comments and feedback until February 23, 2018.

How to explain ‘new’ things like bitcoin …

Let’s assume for a moment around year 1860 you are horse rider working for the Pony Express. You and your colleagues are doing, on a daily basis, a fantastic job delivering messages between the Atlantic and Pacific coasts ( it takes approximately 10 days). During a ride you start to see placement of wires on poles. You try to understand and to explain to your partner of this. What would you say? “ they are building a continental fence high up in the air” or at some point you understand some aspects of what this new thing does. At the moment of realisation would you still be convinced that only people on horses working for solid companies can reliably deliver messages over such a long distance. Eventually working in this paradigm will no longer be valid as you notice the decrease in demand for horses and riders.

Now let’s switch back to crypto currencies with Bitcoin as the prominent example and have a look at some of the arguments discussed on various media these days. It is very difficult to explain cryptocurrencies, such as Bitcoin, with a simple comparison to something else.

“Bitcoin has no value” – this is somehow the wrong discussion. Most currencies don’t have one – fiat currencies have declared value by authorities and maintain it as long as people trust the system. The latin word ‘fiat’ simply means “it shall be’ – an authority declares something to be a currency. Bitcoin was created in the last financial crisis. The genesis block contains the message “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. It is an attempt to create a decentral form of money where no central authorities have an influence. So the key question is not the ‘value’ – it is about how trust is built. What’s better – the declaration of an authority or the community?

“Bitcoin is a currency” – sounds reasonable as we all deal with one or more currencies each day and as Bitcoin started to become an aspect in our daily life. But what is a currency? It turns out that currency definitions like the one on Investopedia are not so helpful.

“Currency is a generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. Used as a medium of exchange for goods and services, currency is the basis for trade. ”

If this definition is true, then Bitcoin is not a currency as it is not issued by a governmental authority. Also, the definition of money is linked to a government. Hence Bitcoin is also not money, if the definitions are considered to be valid.

“Bitcoin is not a medium of exchange” – as transaction costs and volatility are high and making small transactions unattractive to mine. Although Bitcoin is currently not an option for small amounts but could well be used for large ones.

“Bitcoin is made of thin air” – on the basis that there is no underlying physical resource. But what does this mean? Bitcoin is itself a resource on a strict mathematical base. It is not created out of thin air – its creation is the result of a well-defined and completely transparent algorithm which we all can verify and decide to trust or not to trust. Comparing this to ‘fiat currencies’ do you know how ‘fiat currencies’ are created? Do you know who decides to increase the amount of currency or to adjust the value of one against another currency? Is this done in a transparent way?

“Bitcoin is fraud” – what is the basis and evidence of such statement?. Looking at the original whitepaper of Satoshi Nakamoto this is simply wrong. Sure, there are fraudulent use cases, but this is also the case with all other currencies or assets. It turns out that Bitcoin is not really a good medium to be used e.g. in ransomware. All transactions in Bitcoin are publicly observable – we do not know the individual owning an address but that does not hinder to monitor target addresses and intervene at exchanges when they are used. In other words – using Bitcoin always leaves traces while using e.g. cash does not.

“Bitcoin needs regulation” – sounds also great as rules are essential to create trust. A system which is weak needs a lot of surrounding rules and interventions while there are systems which contain the rules transparently in their core. Bitcoin itself is regulated by the maths embedded in the system itself but not by the traditional financial services regulators or national banks. What authorities can and should do, is to think about the exchange of Bitcoin against the fiat currency they oversee and the implications.

“Bitcoin is the mother of pyramids” – sounds also somehow true as the ones who bought Bitcoins early now profit from those who come late. But what is a Pyramid Scheme?

“A pyramid scheme (commonly known as pyramid scams) is a business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or sale of products or services. As recruiting multiplies, recruiting becomes quickly impossible, and most members are unable to profit; as such, pyramid schemes are unsustainable and often illegal.”

At least I’m not aware somebody recruits members in a multiplier scheme. And anybody can decide at any time to get buy or sell Bitcoins. Hence the comparison seems also to be misleading.

“Bitcoin is a bubble” – looking at the price evolution is 2017 suggests that this could be a bubble. But what is a bubble?

“A bubble is an economic cycle characterized by rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive selloff occurs, causing the bubble to deflate.”

Well, it is most likely some sort of a bubble – there will be price corrections and at some point in time Bitcoins will be super-seeded by a technology eliminating its constraints in terms of fairness, transaction rate and energy consumption.

“Bitcoin uses enormous amounts of energy” – this seems to be one of the concerns people love to make comparisons and also promote the idea that more transactions results in more energy consumption. Yes, it uses a lot of energy but this energy is what makes the network safe in the current proof of work- mining. An attacker would need to invest a substantial amount of these resources to destabilize the bitcoin network. The amount of energy used does however not correlate with the number transactions processed.

“Bitcoin is the new gold” – this seems to sound right when thinking about mining Bitcoins. There are the miners who produce gold and the limited supply makes gold valuable. The amount of natural gold on the planet is limited like the total amount of Bitcoins. But astro mining will change this for gold not too far in the future – experts talk about 20 years from now. Bitcoin’s mathematical foundation stays.

These points are properly summed up in Steve Wozniak’s statement “Bitcoin is mathematical. I am a mathematician. There are only 21 million. It is more legitimate than other systems”.

The following is a pretty good description:

It says that it is a limited resource currently slowly increasing day by day peaking at 21 million. So far, all resources which are limited and of interest, increased in value. While Bitcoin was rather unknown even 2 years ago it is now a hot topic in all media with people making harsh statements primarily defending their own interests.
Steve also calls it a system – there is neither a government nor a company with management nor an individual running Bitcoin. The system is very cleverly built – it is an amalgamation of many disciplines and was so far self-balancing gravitating towards a stable state where all the participants jointly benefit.

Maybe we add the following characteristics

The system is transparent – everybody can observe all transactions.
The system is democratic – everybody can use it or become a miner.
The system is self-balancing – no government or company decides its direction
The system is energy inefficient – a result of the proof of work mining approach
The system is not completely fair – miners can prefer juicy transactions
The system is open – all technology is freely available

A hyperconnected digital economy needs inherently digital media of exchange. Bitcoin is most likely the first step into such a direction. It’s ten years history demonstrates that such a system is possible and triggered a whole new set of echnology innovations. Crypto currencies represent a fundamental upgrade to the economic systems of the world. Once they have matured and are integrated into the mesh economy, the world will look very, very different.

Links:

Giving direction …

The world continously evolves and changing exponentially (see Change is inevitable ….). Not long ago the pace in companies was much slower. Propagation of information took time and the production of goods was typically labor intensive. The main challenge was organizing processes and workforce efficiently towards maximal outcome. These mechanisms which used to work well in the industrial age increasingly fail to produce beneficial effect in the information age.

Today’s environment routine work is automated and commoditised whereas engagement and creativity have become major assets of organizations. Great organizations have a shared goal, a state they want to reach. This reason d’etre has become more important than ever before. The vision is the mechanism to create a pull into one direction. A practical guide for creating plans, setting goals and objectives, making decisions, and coordinating and evaluating the work on any project, large or small. It is the source for motivation within the organization.

A vision captures clear and inspirational long-term desired change(s) resulting from an organization or program’s work. The vision is important – it expresses why the organization is required and provides guidance and direction to all who engage.

Alzheimer’s Association: A world without Alzheimer’s

It is obvious that the people engage here want to contribute to a world free of Alzheimer. They can do this however as they want as the vision does not say what has to be done. Everybody can contribute with his skills and abilities. People will have different perceptions on the importance of this organization, but nobody will be against this vision.

You may now say that this is just a simple and straight forward special case. Indeed – it should all start with a ‘why?’ which leads to people sharing the idea forming an organization. The vision is what makes this organization special and different from others.

Below is a list of vision statements of some other organizations

We create the technology to connect the world
We believe in what people make possible
Organize the world’s information and make it universally accessible and useful.
To be Earth’s most customer-centric company, where customers can find and discover anything they might want to buy online

You engage and be part of only if you agree with the vision . Shaping a vision is not easy – it requires creativity, setting standards and enforcing clear decisions. People may like it, dislike it or find it irrelevant.

Many incumbent companies in the financial sector started with a clear vision. Some of these goals were reached and the companies just continued to do what they are doing. They just repeat what they have done in a better and more efficient way. Without having a vision it becomes difficult to be innovative and cost efficiency starts to become the main goal.

As a little exercise look at the web pages from incumbent organizations in the financial services industry and try to find their vision statement. It’s interesting that only a subset of the companies have one.

XYZ’s vision is to be recognized as a leading manufacturer of protective materials for high reliability applications throughout the world.
XYZ’s main commitment is to provide its customers with the best solutions possible

These two examples sound really trivial and the vision can be used for most types of organizations. Or is there a company who does not want to be reliable or provide the best solutions? This lack of purpose is dangerous – as there are many organizations with the same aim there is no evident reason, why this specific one is really required.

This lack of a vision is also dangerous as the new organizations all have vision – typically not talking about themselves but about the state they want to reach.

We believe everyone should be able to enjoy a healthy financial life.
We’re building this bank for you. We’ll learn and adapt to you, celebrating your individuality in every way.
By solving your problems, treating you fairly and being totally transparent, we believe that we can make banking better.

Compare the examples – which one is more appealing? Where would you like to engage as an employee or become a client? The incumbents benefit from their history as people are quite slow in changing their habits. But “time to change” is not the factor we should rely on in this “game” as when change happens it will be instantaneous.

Many incumbents relax on the fact that they are today systemic relevant – but the system could change and the relevance vanish with it. It feels much better to have a clear vision of the future than to rely on the past.

So it’s time for many incumbent organizations in financial services to hit refresh …

FINthinker’s Predictions for 2018

2018 will bring …

2017 was an interesting year where many developments started to get real traction. Just think about blockchain, bitcoin and artificial intellgence.

2018 will be even more interesting and substantially more challenging. A few predictions for 2018 are as follows:

There will be three core changes for financial services:

Tokens (see Towards a digital barter economy?)
Blockchain
Self Sovereign Identity (see Self Sovereign Digital Identity)

All three aspects levitates a shift towards a distributed decentralized financial system. This affects the core and challenges legacy status quo and its existence in the future.

In addition fueled by the increasing tokenization and availability of blockchain based systems there will be a shift towards

Mobile Payments
Holistic mobile wallets
Global Solutions

There will be no other options for incumbents to integrate into the evolving mesh than to provide API’s to access information and services and to start to rely on others to provide crucial information. Self contained and closed financial services companies as well as local solutions will increasingly face headwinds.

Open Banking / API’s
Global solutions

Last but not least – user interfaces will become much more natural and transparent. The users will be amplified with new sense and access to information supported by intelligent agents.

Natural interfaces, Voice (see Noisy Channel(s) to Channel-less )
Artificial intelligence, Smart Assistants

Regulators will start to come up to speed with the changes. They will find ways to agree with business changes but also ethical standards across borders acknowledging the global nature of digital eco systems. A big challenge will be on the very old tax systems which are not ready yet for the shaping economy.

Tax System

These changes are fundamental – there is a ongoing paradigm change where inherent distributed digital approaches start to outperform the automated legacy processes. There are two big dangers out there

Underestimating the ongoing change (see Noisy Channel(s) to Channel-less)
Overestimating the achievements made (see Digital Tur Tur)

Many of the current developments seem to turn time back and bring up systems again which were used in the past but difficult to apply as physical distance was a limiting factor. Digital changes this – the world becomes some sort of a global village. Have a look at Yap, The Island Of Stone Money – the first productive blockchain system.

Our 2018 predictions by 11FS