14.Blockchain is an electronic ledger that records and verifies transactions made using crypto-assets. In its written evidence to the Committee, the Bank of England explained how blockchain emerged with crypto-assets:
The […] innovations behind [blockchain] emerged from the initial crypto-asset, Bitcoin, which was introduced in January 2009. Bitcoin was an attempt to build a payment system that did not rely on a trusted authority (such as a commercial or central bank) to maintain the record of payments and balances (the ‘ledger’). Importantly, anyone can participate in the validation of Bitcoin transactions—the network is ‘permissionless’ and its underlying blockchain (the database or ledger of transactions) is public. The Bitcoin network relies on multiple participants maintaining identical copies of the ledger and employs a process to come to consensus on the contents of, and updates to, this ledger.
15.Moving away from its origins with Bitcoin, the Digital Currency Foundation explained that the term blockchain is now used to describe any database that is distributed amongst its users that, when it is updated, all users in the system can see the new information and verify it:
[Blockchain] is a database […] that works as a decentralised […] way of storing large amounts of data. […] transactions are recorded on a ledger which are validated and recorded in blocks (hence ‘blockchain’) forming one timestamped ledger which is distributed and updated over the network in real time. The validation of blocks is reached through this consensus of participants in the network […] All blocks timestamped and all transactions [and information on the blockchain] are accessible to participants.
16.The uses of blockchain can be extended beyond payments. The following section of this report considers the advantages and limitations of managing data in this way.
17.Ryan Zagone, Director of Regulatory Relations at Ripple, explained the advantages and efficiencies of a database or ledger that participants share and verify:
Blockchain, as a technology, allows us to validate, store and synchronise information across many different parties more securely and more efficiently than we have been before. We are looking at reviewing information for its accuracy and authenticity. We are storing it in a way that cannot be tampered with. We are synchronising it across many different parties, even globally. Validating, storing and synchronising information has many different use cases. There is a lot of hype around the technology right now. People recognise that this type of capability allows us to be much more efficient in how businesses or commerce can be conducted. There are lots of use cases for that. It is very general tech.
18.In its written evidence, the Bank of England also noted that blockchain could “increase the efficiency of managing data, by reducing data replication and associated reconciliation processes.” Similarly, the FCA’s evidence stated that blockchain could lead to “cost and time reductions arising from the removal of intermediaries required for processing a transaction.”
19.Chris Taylor, Chief Operating Officer of Everledger, argued that a key advantage of storing data in a blockchain form, [over conventional databases], is that it becomes “immutable” (i.e. it cannot be changed retroactively, except by consensus among users):
In a traditional database, records can be edited quite easily, either by an administrator or by other people who have access to the database. In a blockchain, information cannot be edited. It can be appended to, but the original information remains as a form of record. That makes it a useful tool when trying to trace back the history of transactions related to that database, whether that is related to assets or whether that is related to currencies and other kinds of transactions.
Similarly, the Bank of England states that “through the creation of instant, permanent and immutable records of transactions [blockchain] enhances transparency and auditability.”
20.Dr Kotsialou, a researcher of blockchain at King’s College London, argued that a further advantage of blockchain is the resilience and security it can offer:
[Blockchain] is more difficult to hack because the data is replicated to every node of the network. […] [If the data] are replicated in all the nodes of the network then it is harder to change. It is also the data validation. The rules that the nodes follow in order to validate votes, or any other transaction, are all public. Everyone can check what these rules are and everyone can check that the transactions in a block have been validated in the correct way. In general, the more decentralised we make a system, the more trusted it will be.
21.Despite the potential advantages of blockchain, the Committee also received evidence describing a number of limitations.
22.In written evidence, the Bank of England noted that scalability and reliability of blockchain was a significant challenge, and that such technology “will need to prove it can reach the performance standards of more conventional technologies.” Mr Taylor from Everledger told the Committee that blockchain is not automatically more reliable than other databases, and “is the same as any system. It is garbage in, garbage out. You have to make sure that the participants that you are allowing to contribute on to the network are trustworthy.”
23.The Bank of England also noted that further “consideration will be needed around how a distributed system is controlled and governed.” Martin Walker, a Director at the Centre for Evidence Based Management, shared this view, arguing that a decentralised blockchain may raise risks that no one is accountable for:
The difference when people talk about decentralised, which is where the big regulatory red flag comes up, is no one is accountable. That is a very serious problem, in terms of consumer protection and law enforcement, but also if you are linking the existing world financial system into something that is generally decentralised, where no one is in control.
Jorge Stolfi, Professor of Computer Science at the State University of Campinas in Brazil, noted in written evidence that the absence of a central authority can mean blockchain users remain anonymous, as there is no-one to confirm their identities. This “relative anonymity”, he argued, made blockchain useful as a means of facilitating illegal activity.
24.The original purpose of blockchain and Bitcoin was to create an alternative system of payment. Satoshi Nakamoto, the founder of Bitcoin, intended it to be “a purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution.”
25.In his speech on The Future of Money, the Governor of the Bank of England, explained that “in the depths of the global financial crisis, the coincidence of technological developments and collapsing confidence in some banking systems sparked the cryptocurrency revolution.” The peer-to-peer nature of blockchain enables individuals to transact without going through a financial intermediary in the traditional financial system. Transacting with crypto-assets also means that there is no reliance on a central bank issued fiat currency. Advocates claim that transacting through crypto-assets is more trustworthy than centralised fiat money as crypto-assets are “immune from […] debasement [and] its use is free from risky private banks.” Marco Santori, Chief Legal Officer and President of Blockchain, explained that for some people blockchain represents an alternative way of transacting and living:
People do not come to Blockchain just to speculate, or to try to buy something for a dollar and sell it for two. They come to Blockchain so they can live and so they can escape Governments that have been irresponsible with their currencies. They can prevent their hard-earned savings from being nationalised. They do it so they can transact in a way that does not rely on an intermediary that charges them a hefty fee.
26.Obi Nwosu, Chief Executive Officer of Coinfloor, explained to the Committee that payments using crypto-assets rather than traditional currency could further financial inclusion for individuals who do not have a bank account:
With cryptocurrency, maybe it is not as good as a depository bank account but it is better than nothing at all if they want to buy something online. […] Governments around the world, and especially the western world, have policies around improving financial inclusion. Cryptocurrency could be an alternative or a mechanism in achieving that.
27.While crypto-assets may provide a potential payment service solution for people without bank accounts, users would still have to acquire crypto-assets with conventional currency, which generally requires access to banking services. When asked how this problem could be overcome, Mr Nwosu told the Committee:
Instead of asking for payment [of wages] in a fiat currency, I ask for payment in cryptocurrency. That is the simplest way. […] In places where people are unbanked, instead of accepting currency in cash, they may say, ‘I want to buy something online; I will accept currency in crypto for whatever task I do’, whether it is giving you some water, washing your car or whatever it may be. They use that cryptocurrency to purchase something online.
28.Izabella Kaminska, Editor of the Financial Times Alphaville, was sceptical of crypto-assets being a “panacea” for financial exclusion. She said “we should not confuse financial inclusion as a technical problem. It is very much a socioeconomic problem.”
29.Finally, some argue that crypto-assets could be more efficient that centralised fiat money because “the underlying [blockchain] cuts out intermediaries like central banks and financial institutions and allows payments to be made directly between payer and payee.” However, the efficiency of blockchain and crypto-assets is disputed, as set out below.
30.As discussed in Chapter 1, blockchain is not being widely used as a payments system, and crypto-assets are not being used as a medium of exchange, because they are currently failing to perform the three key functions of money: as a store of value, a means of payment and a unit of account.
31.In its written evidence to the Committee, the Bank of England noted that crypto-assets are too volatile to be a credible store of value:
Measured against the US dollar, Bitcoin is ten times more volatile than sterling, and other cryptocurrencies are even more volatile. If contracts were specified in cryptocurrencies, the value received in payment may be significantly less (or more) than the value at the time of the agreement. Retailers accepting payment in crypto-assets would have to take significant exchange rate risk whilst holding the crypto-asset.
32.In the Bank of England’s Quarterly Bulletin article titled The economics of digital currencies, the Bank of England explained that “most existing [crypto-assets] incorporate strict rules that govern their creation, following a pre-determined path to a fixed eventual total supply.” For example for Bitcoin, the “system’s protocol dictates that there will be an eventual total of 21 million, which should be largely reached by around 2040.” David Gerrard, author of Attack of the 50 Foot Blockchain, argued that the limitation on the supply of Bitcoins meant that deflation was an explicit design feature. He noted that “Nakamoto [the pseudonymous creator of Bitcoin] put forward as a positive for Bitcoin that it would go up in price, with greater demand and use.” However, he argued that this “disincentivis[ed] its use of a currency; if your money is worth more tomorrow, you won’t spend it today.”
33.The Bank of England argued that crypto-assets and blockchain “do not function well as a means of payment.” Firstly, crypto-assets and the underlying blockchain face capacity constraints:
[Blockchain] cannot handle the payment volumes required. Every day in the UK, more than 30 million electronic payments are made through Bacs and Faster Payments [payment systems]. In contrast, Bitcoin’s global peak capacity is around 0.6 million transactions per day.
34.The Bank of England also explained that capacity constraints lead to higher costs for transactions made through blockchain crypto-assets:
When demand for crypto-asset payments exceeds the capacity of the network, users must offer fees to ensure that their transaction is at the front of the queue of payments. In December 2017, when demand for the Bitcoin was highest, average fees peaked at nearly $60 per transaction whilst tens of thousands of lower-fee transactions sat pending for hours at a time.
35.A blockchain’s fundamental requirement for transactions to be verified by participants also limits the speed at which transactions can be verified:
Cash and contactless card payments can be confirmed instantly. In contrast, transactions on crypto-asset platforms are only “confirmed” when they have been included in a block of transactions that is written to the ledger. For Bitcoin, it takes an average of 10 minutes to receive the first confirmation. As good practice and for higher value sales, sellers are advised to wait for six confirmations (around 60 minutes) before considering the payment to be irreversible. This is impractical for most physical retailers.
36.The verification required of blockchain transactions requires large amounts of computer power and, correspondingly, energy. Mr Gerrard argued that:
The problem is that decentralised systems are vastly less efficient that centrally controlled ones. This is reflected in the […] waste of power involved in Bitcoin’s “proof-of-work” […] system, where it uses 0.1 per cent of the world’s total electricity consumption, or an amount comparable to the entire Republic of Ireland.
Such energy costs need to be paid for, and the Bank of England explained that these high energy costs will lead to higher transactions costs:
If crypto-assets were to replace traditional currencies, the use of proof-of-work would make crypto-assets inherently more energy intensive per transaction than conventional payment systems and imply a higher cost per transaction.
37.Throughout the course of the inquiry, the Committee received evidence on how the blockchain has been adapted to serve a wider range of purposes. The Bank of England stated that:
It is useful draw a clear distinction between […] the underlying technology powering the majority of crypto-assets on the form of public or ‘permission-less’ distributed ledgers, and the significantly adapted versions of [blockchain] that are being developed for use in financial services on private or “permissioned” distributed ledgers.
38.The Bank of England explained that the “distributed ledger technology arrangements being explored in financial services are generally ‘permissioned’ i.e. participants require permission to participate in the network, and its underlying distributed ledger is private.” For example, R3, an enterprise software firm working within the financial services sector, is developing a platform called Corda “[to enable selected] institutions to transact directly [with each other] using smart contracts.” Ms Kaminska and Mr Walker also cited other examples of the deployment of blockchain in capital markets, including “Digital Asset Holdings’ and the Depository Trust and Clearing Corporation’s work on repos; Digital Asset Holdings’ project to replace the back-office system of the Australian Stock Exchange; and Axoni’s work on equity swaps.”
39.In their written evidence to the Committee, Ms Kaminska and Mr Walker acknowledged that “a very wide range of claims have been made […] about the potential benefits of applying blockchain […] technologies in the financial services sector.” However, they argued that in most cases, “how blockchain [would] specifically solve problems or generally make things better [is] not explained.”
40.In discussing examples of the wider application of blockchain to the financial services sector, Ms Kaminska and Mr Walker noted that many of these do not deploy crypto-assets, restrict the number of participants on the ledger and have “a central body […] responsible for maintenance of the ledger and […] granting access to it.” They added that, in many cases, these examples were “so different from the original blockchain, it becomes meaningless to refer to it as blockchain.”
41.The Committee also received evidence on the use of blockchain in verifying the quality of physical assets. Mr Taylor explained that the company he represented, Everledger, used blockchain to track and verify diamonds:
The blockchain ledger allows us to capture each step of that asset along its journey through the supply chain. That can be through trading patterns, through import-export processes or through grading houses. All that information is gradually building upon the original record of the diamond. That allows the participants in the supply chain to have greater confidence around the authenticity, existence and attributes and history of those items.
42.Mr Taylor argued that using blockchain to track assets through a supply chain also delivers wider benefits to a range of stakeholders:
It also enables other participants in the supply chain, such as Governments, to have greater confidence about what is crossing their borders. It also provides other participants, such as finance houses and insurers, a way to identify if assets have already been financed, for example, or have already been insured, or are already the subject of an insurance claim previously. It has a high value in the reduction of fraud across the industry.
43.While many claims are made as to how a blockchain could improve supply chain verification, practical problems would still need to be overcome. Mr Walker told the Committee that, when using blockchain to track a supply chain, or to verify the provenance of a physical asset, “the recurring problem […] is actually keeping the data record linked to the physical object.” He noted that “there are many, many stages in [a] supply chain, at each of which some kind of fraudulent activity could occur.” Thus there is still a need for “people [and] auditing […].” This corroborates with Mr Taylor’s argument, referenced earlier, that a blockchain “is the same as any system. It is garbage in, garbage out.”
44.An Initial Coin Offering (ICO) is a way of raising funds from the public using a crypto-asset. ICO issuers accept a crypto-asset, like Bitcoin or Ether, in exchange for a proprietary ‘coin’ or ‘token’ that is related to a specific firm or project. The digital token issued may represent a share in a firm, a prepayment voucher for future services, or in some cases offer no discernible value at all. Often, projects funded by ICOs are in a very early stage of development or are entirely fictitious.
45.David Raw, Deputy Director of Banking and Credit at HM Treasury, told the Committee that the scale of the growth of ICOs has been significant and that from January 2018 to end May 2018, approximately $10 billion was raised through ICOs globally.
46.The regulation of ICOs, and the risks to investors, are considered in the next chapter.
47.Crypto-assets and blockchain were originally designed as an alternative system of making payments in exchange for goods and services. But even the most widely-used crypto asset—Bitcoin—is not widely accepted by merchants. Moreover, the blockchain that underpins Bitcoin transactions cannot process anything like the volumes of transactions that would be required for it to become a mass-market payments system. Even at current levels, the energy costs of verifying transactions appear disproportionate to the potential benefits of a decentralised payments system.
48.The slow, costly and energy-intensive verification process for transactions is not unique to Bitcoin, but a fundamental feature of crypto-assets based on public, decentralised blockchains. This may ultimately limit the extent to which crypto-assets and blockchain can replace conventional money and payments systems.
49.The arguments put forward that crypto-assets could further financial inclusion are unconvincing. Efforts to further financial inclusion are best focused on reducing the number of people without access to bank accounts, rather than increasing the numbers with access to crypto-assets.
50.There are a number of examples of blockchain being deployed in the financial services industry and supply chain management. The Committee is supportive of good innovation, but notes that blockchain should not be pursued for its own sake. Rather, Government and industry should identify what problems exist and consider whether blockchain offers the most appropriate solution. The Committee recognises that blockchain technology may have the potential to solve problems caused by a lack of trust in data integrity and may be a more efficient method of managing certain types of data in the long term, offering higher levels of security than centralised databases.
51.However, at present—although small scale uses for blockchain may exist—the Committee has not been presented with any evidence to suggest that universal applications of the technology are currently reliably operational.
14 Bank of England () para 20
15 Digital Currency Foundation () para 3.1
16 Ripple is a company that uses its private blockchain to connect banks, payment providers, digital asset exchanges and corporates to its own system, RippleNet. Participants of RippleNet are able to send money globally with instant, on-demand settlement. Ripple also has its own crypto-asset, XRP, that is used as a bridging currency underlying money transfers between different currencies on RippleNet.
18 Bank of England () para 23
19 Financial Conduct Authority () para 8
20 Everledger is a firm that uses its private blockchain to track the provenance of high-valued assets in supply chains, such as diamonds.
22 Bank of England () para 23
25 Bank of England () para 25
27 Bank of England () para 25
29 Professor George Stolfi ()
32 Fiat currency is currency that a Government has declared as money, and is typically backed by the central bank and not backed by a physical commodity. Examples of fiat currency include Pound Sterling, Euro and US dollar.
33 Speech by Dr Mark Carney, Governor of the Bank of England, , 2 March 2018
34 Blockchain is a company that provides a software platform for crypto-assets. Blockchain provides its customers with digital wallets, which enables customers to own crypto-assets.
36 Coinfloor is a crypto-asset exchange which enables its customers to buy crypto-assets.
44 Bank of England () para 6
47 David Gerrard () para 8
48 David Gerrard () para 8
49 David Gerrard () para 8
50 Bank of England () para 7
51 Bank of England () para 7
52 Bank of England () para 7
53 Bank of England () para 7
54 David Gerrard () para 6
55 Bank of England () para 7
56 Bank of England () para 2
57 Bank of England () para 22
58 Smart contracts are self-executing contracts that are written on software which are able to tell when, for example, payments have been made, which could automate delivery or the dispatch of goods without human intervention.
59 R3 ()
60 Izabella Kaminska and Martin Walker ()
61 Izabella Kaminska and Martin Walker ()
62 Izabella Kaminska and Martin Walker ()
63 Izabella Kaminska and Martin Walker ()
64 Izabella Kaminska and Martin Walker ()
71 FCA, , 12 September 2017
Published: 19 September 2018