Views on Blockchain Banking

Source of article –

Excerpts from the article responded to inline.

Blockchain Banking or Crypto Banking has been one of the applications of the Blockchain technology which is being discussed in some security circles. It is being hailed as “Secure”, “Transparent”,” resistant to fraud” and eliminates the need for third party intermediary and therefore is faster than conventional Banking, reduces transaction costs and increases financial inclusion.

These claims are mostly true (there are exceptions though, but largely true). Intrinsically, it was not meant/designed for frequent transactions ( Same reason as to why UPI lite has been introduced now). But there have been workarounds as improvement protocols, which have addressed the issues of scaling and transaction time. Some of those improvement protocols have been included in the main codebase of the blockchain.

  • Secure – Well secured as the entire system is cryptographically built.
  • Transparent – As the entire ledger can be viewed on the explorer. Any party lying about fund transfers can be instantly found out.
  • Fraud resistant – Compared to conventional banking, the weakest security link(people) is removed in the process of transaction. This largely reduces the fraud risk. But fraudsters will always try to find loopholes and workarounds in the system to gain some advantage over other users of the system. The system’s perfectness is only to the extent of how the creators/maintainers are able to anticipate the fraudster’s mind. So will support the fact that it still is a better fraud resistance than conventional banking.
  • Third party intermediary – Entire process is governed by rules. So fuzziness in the system is drastically reduced as compared to conventional banking. No third party involved. The network replaces the third party intermediary.
  • Faster – Yes, definitely for international wire transfers and large amount transfers. As pointed out before, not a fit for high frequency banking. But workaround improvement protocols (eg side chain transactions)  can make it fit the bill to practical transaction volume and time requirements
  • Transaction cost – A 200% yes. The entire cost of transfer of huge amounts in thousands of crores is merely a few thousands. The fee is not charged on the transaction amount, but rather on transaction storage. Unlike conventional banking, where the cost is a percentage of the transaction amount (rather than a fixed fee)
  • Financial Inclusion – Government should have used this as a tool to include more people in the system (beneficial in the long run) rather than thinking it as a threat. This being a novel technology, has the potential to bring in more people to the formal financial system, may be as a fad or otherwise.

This thought process needs to be moderated with the possibility of destruction of the conventional financial system which would be detrimental to the society.

This is bound to happen sooner or later as better technologies always prevail. Not that the traditional financial system doesn’t have any pros over this new system, but blockchain has sustained since 2009, in spite of numerous efforts to take it down. (Taking bitcoin blockchain as the reference). Can both coexist? Yes. Who will hold the major chunk of the business? Blockchain (value wise), Traditional system(volume wise)

Lets say the traditional financial system is reduced to an insignificant chunk, it would not still be detrimental to the society as the block chain system will prevail as a better system technology.

When Banking system adopted technology, there was a claim that the costs would reduce since back end processing was automated and became more efficient and error free. However this promise did not materialize. Banking became costlier for the customer and more frauds surfaced.

This is a statement made to make technology look like a useless system and inefficient over the older manual system. This is  a false statement. The reasoning needs to be understood. The technology automation is only to the extent where there is no human involved. Since it became easier for banking employees to do their work after tech implementation, they blamed their inefficiencies on the technology. Every technology works on rules and as employees were themselves inefficient to learn or execute or were being simply lazy, they blamed it on the technology, largely to save their jobs. That’s what made this general trend of technology being slow and less productive. Also the technical system workflows are designed as per the user needs. So if the user communicates inefficient needs, the system will be designed accordingly. (Example, only recently they have started using tech properly for a basic procedure as regular KYC procedure and that still needs a lot of improvement for automation). These employee inefficiencies lead to more banking costs and service dissatisfaction.(The SBI “lunch time” memes arent just memes!). We don’t have to be emotional about systems. Better systems always replace inefficient systems.

Similarly, the Crypto Banking having all the virtues is also a myth that would destroy the current system and introduce a more risky system in the coming days.

Crypto banking is not a perfect system. It is still undergoing rapid development and evolution. Sooner we will have better and robust systems than the current versions. It certainly wont destroy the current system (may be over time will replace). The risk is defined and regulated – Eg – if the private keys are lost, no way to recover them. Some providers issue backup / restore keys initially itself to solve this problem. But essentially risk is largely regulated.

Essence of Block chain technology is that a transaction record is kept in a public ledger and all the “Node Owners” will have copies of all the transaction blocks. The transactions would however be encrypted. Hence the system would multiply the data storage several folds. Since the transactions are encrypted, the node owner may only view a transaction as from X to Y of a certain value and type and not knowing who is X or Y. Hence the claim of “Transparency” is not correct. In fact If X or Y is a fraudster and imposter, the person authorizing the transaction wo views only a hash value representation has no idea of the fraud.

Data redundancy? Yes. But that’s the technical tradeoff for having an intermediary-less system. The transactions are actually public in some blockchains. So anyone can actually look into them and see the transaction execution and get a confirmation on it. That’s how blockchains offer the feature of transparency. Also one doesn’t need to store (download yes, but store no) all the historical data to be able to run the blockchain. the blockchain client computes hashes from the downloaded data. But once done, it doesnot need to store it locally. One can specify the last “n” blocks to store.

The node owner has no business knowing the transactions being done by the peers. The owner is just facilitating and securing the network by running the full/partial node. Only when the nodeowner gets the specific identifiable data on the wallet addresses mapped to the owner, the owner can know the source and destination of the transactions. But thats true for anyone in the public too.

There is no legal liability on the node owner too as the system (s)he is just facilitating increased network security and transaction discovery. Let’s say even if a transaction being done is a fraud transaction, even then the job of the full/partial node is to just facilitate increased security and transaction discovery. Also all transactions are usually one way. No way to reverse them after they are done.

Secondly, if the node owners are members of public there would be no liability attached to their authorization and hence fraud victims cannot hold them responsible. In a Banking environment or a private block chain where the block chain is owned by the Bank itself with its own officers being the nodal controllers, the responsibility can be fixed on the Bank. But this would not eliminate the need for the intermediary. What would change is that the transactions would be stored in terms of encrypted blocks instead of the central server (which also can be encrypted).

The purpose of the blockchain is to have a distributed system instead of a centralized. As soon as it is closed within a defined boundary of institutions (non public), they can be manipulated by the 51% attack. (if 51% of nodes are manipulated, the blockchain can be manipulated). Being in the public domain, ensures that it doesnot happen. Hence a private blockchain would not be trustable for this purpose. Again all chains aren’t encrypted. The primary job of the node is to increase the network security by increasing the system entropy and transaction discovery. If these functions are manipulated in a non auditable blockchain code, it wont be trusted by its users and thus wont be used.

If the Banking ledger is kept as a “Public Block Chain” then we will be converting the money of the customers into a virtual data chain which if unauthorizedly modified, is no body’s responsibility

The purpose of a public blockchain is to keep the system transparent and secure. The data is immutable. Once, pushed into the blockchain, it cannot be modified. Only way to manipulate it would then be the 51% attack. As it is public and secure, responsibility question doesn’t come in to the picture.

In the legacy Banking system, the depositor lends his money to the Bank with a contractual guarantee of the same being returned with interest. The Bank is expected to invest the money received in loans and earn an income besides contributing to the development of the business and creation of further assets through a multiplier system. The block chain banking would block the multiplier system that works in the legacy banking system creating money for development. It would be like every depositor keeping his money in his house and is unproductive.

The legacy banking needs to be be understood by the functions it offers (store/retrival/transfer of value, lending, borrowing). It has created a complex hotch potch of simple independent functions. and the reason it has done this is to profit and sustain in the system. The primary banking body is RBI in India. As it doesnot want any customer side direct liability, it has delegated its fiscal management tasks to its subsidiaries – banks. Since, these banks need to run sustainably, they need some way of income to support their operations. The way that income is generated is by manipulating the banking process (which could have been totally independent functions – store/retrival of value, lending, borrowing) to create a system which entangles all these functions to create a complex banking system. If one of the functions fail the entire system fails, for no fault of the users of those/other functions. This is evident in the huge NPAs seen over years and bankruptcy of the banks. Even the most secure instrument (FDs) are guaranteed only by a limited amount and not by their full value. The bank uses the idea of interest to lure its customers into having no liability on the bank. Imagine a scenario where the end user public only loses the interest value + inflation if they utilize only the store of value function. yes they lost value, but not to the extent when the bank becomes bankrupt. This coupling of the functions is not there on the core block chain and thats where the trust generates as random people cannot change the system based on their whims and perceived pros of the banking functions coupling.

The legacy banks donot offer any service with full value guarantee to the end users who would simply want the store/retrival/transfer of value functions. They are fine with no interest on their wealth as they consider its security more than the interest value it might generate. Here the bank would have full liability in case of failure and cannot use the users funds into bad loans. This “doglapan” of the banks is highly questionable.

All other arguments that block chain banking system will reduce inflation etc are also unlikely to materialize. If money supply is withdrawn from the system, then to some extent money available for purchase of goods and services would reduce and this leads to deflation and reversing the progress of the economy. In the long run all persons who have held their Bank deposits in the form of Block-Chain-Bank accounts managed by private Block-chain-syndicates would be at the mercy of a coterie that would take over the majority of nodes and play with the money of the public. These owners would convert the Block chain holdings into real cash through fraudulent transactions and enjoy their dollar wealth where as genuine depositors would live in a false sense that they have a “Crypto Wealth”.

It will not reduce inflation. Thats economic/monetary policy. Banking is just a tool to achieve the goals of the policy. Money supply is controlled, now, both by the end users and the authority. It cannot make random decisions to suit specific needs. A mathematical approach can be defined for the economic growth. This way whimsical deviations from the policy can be stopped but can be achieved if majority users agree to a specific approach. So now citizens would have a direct say in the economic progress of the country. Delegating that task, has not been very fruitful to the growth and development country so far. As private blockchains can be attached by 51% attack, these are not advisable for this financial function for the larger public. Corruption cannot be controlled with this system. If people are corrupt, its how they are. Corrupt people cannot bypass the mathematical systems and hence they would be mostly against it. Though cash has been drastically reduced in the traditional banking, the corrupt people will always find ways to exchange/barter through some other commodity. This trait reflects the culture and has to be improved/fixed with education, opportunities for people to earn without struggling fo basic needs (which is why they start abusing/corrupting the system then) and making available resources. (USA understands this very well and it has always tried to control resources).

I therefore consider that this would be highly harmful and create a large scale bankruptcy.

This is a respectable viewpoint, but ultimately legacy systems will be obsolete.