16 July 2018

VoxEU: The blockchain catalyst for change

This column assesses the available evidence and likely impact for blockchain technology across a wide range of applications and explores the potential use cases for the financial sector, and the ways in which the organisation of these activities may change over time.

[...]Bitcoin is a major breakthrough because participants are incentivised to select and validate transactions made in its native currency, bitcoin. Through that process, participants can agree upon a continually updated history of those transactions – without the need to trust third party intermediaries.  

Users control their bitcoin via a digital signature system by which they indicate consent to transfer coins. These digital signatures are public, cannot be forged, and can be verified by anyone.  It is important that there is only one version of the transaction ledger because in order to verify a payment, participants look at the ledger to validate that an amount of bitcoin has indeed been transferred. If there were different ledger histories, a malicious user might be able to ‘double spend’, i.e. transfer a single bitcoin more than once, as two payments.

This simple and straightforward idea – and associated software code – has already had a profound effect, encouraging rapid and substantial investment in what is now commonly referred to as blockchain technology.  A blockchain is a consensus protocol used to create an append-only log (in the case of Bitcoin, a transaction ledger) that can then be used to form an auditable database (in Bitcoin, a record of who owns which coins). This database is constructed by multiple, possibly distrusting participants and is secured using cryptography so that every entry can be audited and verified.

The result is a common, consensus-based record of transactions that is updated in real-time, one with broad potential applications, including for non-currency exchanges of value and data. In theory, such a system could end the need for costly, time-consuming reconciliation across separate, centralized ledgers run by multiple entities. It could also enable new forms of economic activity that were previously impossible in the absence of reliable, intermediating record-keepers.

We believe this technology could reduce the ingrained ‘cost of trust’ that currently adds friction to commerce and enriches trust-intermediating gatekeepers across the economy.  Blockchain developers agree. They are conceiving of a host of new potential uses: for cross-border payments, in clearing and settlement for financial transactions, for supply-chain management, for device-to-device transactions in the Internet of Things, to create more reliable property and asset registries, to forge portable digital identities, and to improve record-sharing in sensitive areas such as health care. 

However, even after nearly a decade, much remains unclear about precisely what form or forms of blockchains will prevail.  On the decentralised end are already functioning systems like Bitcoin and Ethereum, which are permissionless – meaning there are no restrictions on who can join the system and participate in creating the ledger.  Currently, these open systems are constrained in their capacity to scale by a variety of technical obstacles. Innovative solutions to these problems are being pursued, with the goal of increasing transaction-processing capabilities and lowering overall computation requirements, but they are yet to be adequately proven in live environments. Traditional centralised databases avoid these constraints but rely on trusted entities. They are widely used today, and may still prevail in many areas, perhaps with some enhancements inspired by blockchain-based competitors.  In between are myriad developing – or potentially developing – permissioned blockchains, which have some degree of decentralisation without being open to all.

In the 21st Geneva Report on the World Economy, we assess the available evidence and likely impact for this technology across a wide range of applications (Casey et al. 2018). We also explore in detail the potential use cases for the financial sector, and the ways in which the organisation of these activities may change over time. [...]

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