Most important advances in technology occur when someone combines a variety of innovations in different fields in a commercially successful way. Bitcoin is an exception, a revolutionary advance that people have spent the last 15 years cannibalizing for parts to use in other projects. It’s as if someone built the first automobile from scratch and then left it for others to pick apart: the engine, transmission and steering mechanism all separated and used in other devices.
Goldman Sachs Group Inc. offers the latest example. The bank recently announced plans to spin out its digital-assets platform into a new company for large financial firms to create, trade and settle financial instruments using the technology that underpins Bitcoin. Bitcoin introduced the world to permissionless public distributed ledgers with blockchain, but Goldman is not interested in either the permissionless or public parts of the idea.
This is one version of an ongoing struggle throughout the economy that will be accelerated by the election of the first pro-crypto president in Donald Trump. Will outsiders use crypto technology to disrupt traditional practices and replace established institutions? Or will established institutions adopt just enough of the ideas to maintain their hegemony? The incoming Trump administration has promised changes that could streamline efforts by traditional institutions to exploit crypto tools, which could shift the balance of power away from outsiders.
Currently data on financial transactions are kept in two forms. Each party keeps its own ledger, and these must be reconciled daily between every pair of financial institutions, a gigantic and expensive job, with many discrepancies, that is unreliable during financial crises. In addition, there are many centralized ledgers at exchanges and clearinghouses. Aside from the system’s inefficiencies, delays, expense and unreliability — and I use the word generously — it is not “composable.” Someone cannot insert a new module into an existing workflow without adjusting the entire process end-to-end.
Distributed ledgers allow each financial institution to keep its own copy, which ensures consistency with its internal books and records, but uses the magic of cryptographic techniques to ensure all these separate copies are consistent. In theory, this means instant settlement without errors or the need for reconciliation. There are costs; distributed ledgers demand far more computer resources than either centralized or separate ledger systems, but these seem negligible compared to the benefits.
Bitcoin is public, anyone can see the distributed ledger, and permissionless, anyone can enter transactions and anyone can compete to offer the validation services. Many, but not all, crypto projects are also public and permissionless.
Goldman’s digital-assets platform is private and permissioned — only authorized users can see the ledger and there is a centralized validation authority. That authority is currently Goldman, but the idea of the spin-off is to have an independent centralized validation authority representing all users in order to entice a critical mass of financial institutions — Goldman’s competitors — to sign on.
On a pure engineering basis, this is clearly a superior solution to the current system. It should be cheaper and faster, with fewer errors, and be more robust during crises. It will make life much easier for systemic risk regulators and be useful in everyday financial regulation and academic study. However, the financial industry resists new technology so I’m not confident the idea will succeed. For example, as long as I have been in finance, people have discussed a Financial Products Markup Language — like the Hypertext Markup Language, or HTML, that defines the structure and content of web pages — to provide a universal, machine-readable definition of all financial transactions. It’s a simple technical task and would radically simplify financial processing and reduce errors, but it’s never gained traction.
In one sense, a consortium of established financial institutions imposing a private, permissioned distributed ledger on the world, is a conservative solution. Many people from the technology sector are pushing public, permissionless alternatives that individuals and small institutions could adopt without approval from Goldman and its friends. A commonly cited goal among technologists is to disrupt the financial system and replace the big banks and national regulators.
This battle has been fought many times over the last three decades. Will a technology-native solution replace established companies with a pure internet or pure crypto or pure AI entity? Or will established institutions co-opt just enough of the new technology — avoiding its most disruptive attributes — to become even larger and more powerful?
I’m a technology optimist, so I always expect good new ideas to triumph. I’m pretty confident that in five years the global derivatives economy will run on a distributed ledger. Either major financial institutions will overcome their native conservatism and adopt the type of platform Goldman is pitching, or an aggressive technology start-up will offer a public, permissionless distributed ledger so compelling that customers adopt it without the blessing of these industry gatekeepers. In the former case, the financial system should look much like the present, just a bit faster and more efficient. In the latter case, we could see a changing of the guard with investors dealing peer-to-peer via crypto algorithms designed by teenagers and 20-somethings in California, with traditional financial institutions fading away.
Bitcoin failed to revolutionize the financial system the way many early adopters, including me, expected. But its spectacular innovations continue to drive tremendous change throughout the world. We are currently in a nearly two-year-long Crypto Spring, with the prices of cryptocurrencies such as Bitcoin and Ethereum surging and ambitious new ideas emerging such as combining cryptocurrencies with artificial intelligence and tokenization of private assets. Even if the current exuberance soon turns into the next Crypto Winter, a financial distributed ledger should be among the survivors.
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