A legacy of transparency

Well, the paper that Richard Brown of R3, my colleague Salome Parulava and I put together what seems like an age ago (a year is a long time in fintech) has finally been published! Hurrah! Here’s the reference for you:

Birch, D., R. Brown and S. Parulava. Towards ambient accountability in financial services: shared ledgers, translucent transactions and the legacy of the great financial crisis. Journal of Payment Strategy and Systems 10(2): 118-131 (2016).

The paper itself is not online (you have to subscribe to the Journal for that) but I’m sure that the fine people from Henry Stewart Publications will have no objection to me reproducing the abstract for you here:

The consensus in the finance sector seems to be that the shared ledger technology behind Bitcoin, the blockchain, will disrupt the sector, although many commentators are not at all clear how (or, indeed, why). The blockchain is, however, only one kind of shared ledger and the Bitcoin blockchain works in a very specific way. This may not be the best way to organise shared ledgers for disruptive innovation in financial services. So what is? And why would financial services organisations want to do exploit it?

This paper sets out a simple shared ledger taxonomy and layered architecture designed to facilitate communication between technologists, businesses and regulators in the financial services world and explains why the various forms of shared ledgers might be attractive to financial services organisations, borrowing the phrase “ambient accountability” from architecture to suggest a new way to organise a financial sector.

The paper sets out the “4×4” model that we have used for exploring shared ledger technology with a variety of clients (and have found it to be a very useful tool to help clients develop their strategies around shared ledgers) and then uses this model to discuss the application of shared ledgers to financial services.

 Birch-Brown-Parulava Colour

We finish by putting forward the idea that the legacy of the great financial crisis of the last decade might be the creation of more transparent financial markets. Our focus on transparency was reinforced by the discussions at Money 2020 in Copenhagen, where I think I detected the emergence of “regtech” as a distinct from “fintech” as a paradigm and organising principle. I spoke to a few people about this during the course of those sessions and it seems to me that for many of the financial services delegates their number one problem, the place where costs are out of control and apparently growing without limit, is compliance not technology. Yes, there is great new technology out there but it can’t help unless it has a regulatory context in which to flourish. The idea that there might be new categories of technology (and actually I think that the shared ledger might be one of them because of its potential for a new kind of transparency and a regulatory win-win) where the impact is to reduce the cost of complying with regulation rather than to reduce the cost of delivering a functional service sounds is potentially revolutionary.

What would transparency mean in our context? We envisaged a new kind of financial marketplace where “translucent” transactions that are clear to counterparts, clear in outline to regulators and opaque to others might allow us to set up a transactional environment with ambient accountability. We use the “glass bank” example to create a narrative, and it’s an example that I’ve used before to illustrate the relationship between transparency and trust. Here’s something about it from six years ago:

Transparency increases confidence and trust. I often use a story from the August 1931 edition of Popular Mechanics to illustrate this point.

From Cryptography can bring novel solutions | Consult Hyperion

The legacy of a crisis is often regulation. If we view the shared ledger not only as a fintech (a technology that changes the cost/benefit landscape around financial services) but also as a regtech (a technology that changes the cost/benefit landscape around the regulation of financial services) then we might be able to make the legacy of the last crisis a better and more effectively regulated financial services sector that is a platform for radically new products and services. At a time when so much money is going on compliance and so much momentum is going into “legacy” regtech we realise that the use of shared ledgers may seem radical, but we are convinced that it is time for a new approach.

The replicated distributed shared public ledger formerly known as the blockchain

I had a lot of fun at the FinTech Storm event in London last week. Having been dragooned into being the Q&A ringmaster by the very persuasive Arifa Khan @misskhan), I found myself really enjoying the range and depth of questions coming from the audience. And I had a fantastic panel to work with, with Safello, Coin Sciences, Barclays, Everledger and Coinsilium joining in an open and entertaining (and informative) debate.


I was particularly interested in Gideon Greenspan’s (Coin Sciences) presentation of private blockchains, a subject dear to the heart of many of our clients and the focus gof a great deal of activity at present. The well-known venture capitalist Fred Wilson wrote about this recently, noting that financial institutions might be early adopters of private versions of blockchains for specific, industry-wide applications. As he notes, financial institutions may not be entirely comfortable with the blockchain as it is now.

One concern I hear, though, is that banks like to know who is managing their infrastructure and they are uncomfortable with miners they don’t know, located in parts of the world that make them nervous, providing the transaction processing infrastructure for these applications being built on the blockchain. To me, that is the perfect reason for banks and brokerage firms to take a bit of their data processing infrastructure and point it to the blockchain and start mining it. They could even create a mining pool among the large money center banks. And it is relatively simple for a blockchain application to route its transactions to certain miners to process.

[From Banks and Brokerages Should Be Mining The Blockchain – AVC]

Why would they create such a pool? It would not be to profit from the mining process, a process that (as Gideon pointed out) is enormously expensive and hugely inefficient, because it was created to deliver a specific kind of robustness and censorship-resistance in order to deliver a form of digital cash substitute. But, as he said, some people want to use the blockchain as a tool, not as an ideology.

If you think of the blockchain as an open source, peer to peer, massively distributed database, then it makes sense for the transaction processing infrastructure for it to evolve from individuals to large global corporations. Some of these miners will be dedicated for profit miners and some of them will be corporations who are mining to insure the integrity of the network and the systems they rely on that are running on it. Banks and brokerage firms are the obvious first movers in the second category.

[From Banks and Brokerages Should Be Mining The Blockchain – AVC]

I don’t think this is necessarily the way forward though. It seems to me that “mining” presupposes a particular blockchain architecture. That architecture has been developed, as noted, to deliver a modus vivendi unrelated to the world of financial services, where banks are supposed to trust each other and to know their customers (and their customers’ customers). Financial services do not want, or need, any such thing. This is why it is not at all surprising to see this kind of proposition emerging.

ItBit has revealed new details about its formerly top-secret Bankchain project, a private consensus-based ledger system aimed at appealing to enterprise financial institutions […] without using bitcoin or its blockchain.

[From ItBit Reveals Bankchain Project Won’t Use Bitcoin]

The chap from ItBit who is being interviewed in this article goes on to say that their architecture is “inspired by” the blockchain even it is not actually the blockchain (or, for that matter, a blockchain at all). I love this, and I expect to see more of it in the near future, because there must be a lot of people who think that a replicated, distributed shared ledger is an excellent architectural concept but they don’t want to use a cryptocurrency and nor do they want to use a proof-of-work protocol to defend against subversion by unknown actors since all of their actors are already known and trusted. In fact, I think it may be possible to be argue that most financial institutions, even if they don’t realise it right now, will want to use a different kind of ledger. Blythe Masters of Digital Asset Holdings, who really does understand financial markets in a way that I really do not (she was rather impressively called “the woman who invented financial weapons of mass destruction” by The Guardian) said when speaking at the recent American Banker conference on “Digital Currencies and the Blockchain” that “It’s important to be aware as you think about this that there is more than one distributed ledger technology, not all of them share the same strengths and weaknesses and furthermore, that the thinking in this space is evolving very rapidly” (my emphasis). Absolutely.

In her book “Blockchain“, Melanie Swan points in the same direction. She says that even if all of the infrastructure developed by the Bitcoin blockchain industry were to disappear then its legacy could persist. The blockchain has provided new larger-scale ideas about how to do things. She goes on to say that even if you don’t buy into the future of Bitcoin as a stable long-term crypto-currency, or blockchain technology as it currently is conceived, there is a very strong case for decentralised models. I strongly agree with her view here that “decentralisation is an idea whose time is come” and her characterisation of the Internet as a new cultural technology that opens up techniques such as distributed public ledgers that could allow more complicated coordination across society than those through centralised models. Whether this will, as she says “speed our progress toward becoming a truly advanced society” I cannot say (although I have my doubts!).

So why, I can hear you asking, bother with the replicated shared public ledger formerly known as the blockchain at all if financial institutions already have databases and such like? I think you can see three broad lines of reasoning that add up.

The first is robustness. If some or all of the participants in some marketplace each has an instance of the complete ledger, then the system as a whole might be expected to be more resistant to individual failures, errors and attacks. Think about the recent ATM and debit card system crashes that plagued one of the UK banks.

The second is innovation. When innovative and imaginative people have access to ledgers built from post-1960s components (e.g., APIs and XML), then they will no longer create accounting packages (and laws) that use the virtual world to simulate paper. They will use shared ledger technology to create a new kind of accounting not to do conventional account quicker.

Common sense dictates specialized distributed ledgers will better address specific assets via specialized algorithms and specialized scripting frameworks.

[From Distributed Ledgers Part III: Tokenization of Assets | FiniCulture]

The third is transparency. As I mentioned in the discussion about the “glass bank”, transparency may be the defining characteristic of the new financial order and I expect this to be a focus of our clients’ attention in the near future. I advance the theory here that the next generation of financial applications will focus on transparency as the key to the new way of doing things: the robustness and the innovation are great, but it is in area of transparency that new cryptographic techniques make it possible to create a new kind of ledger. I’ll write more about this in the future, but I will exploring the idea that transparency may be the lasting legacy of the financial crisis in my keynote at Next Bank Barcelona on September 22nd.

You might  add a fourth line of reasoning, which is to do with marketing, herd investors and fast-talking consultants, but we’ll put that to one side for the time being. So for now, let’s just focus on applications that can be “inspired by” the blockchain.

You can’t rob a glass bank, even if you work for it

At the Imperial College (packed) discussion on “Distributed Ledgers – Future Research Challenges“, chaired by Professor Bernard Silverman FRS, the Home Office Chief Scientific Adviser (and a mathematician), a series of speakers (including yours truly) sparked a valuable and fascinating series of discussions around the topic and, in my case at least, left me feeling as if I’d actually learned something.

In the morning, Iain Stewart from Imperial College introduced us to his “Nonsense Watch”. It turned out that his nonsense watch only had two things on it:

  • We hate Bitcoin but we love the blockchain.
  • The blockchain is efficient.

In a memorable presentation, elaborating on these topics, he told the assembled group that the a good way to think about the blockchain is to compare it to somebody swallowing condoms full of heroin and carrying them through customs in your stomach. It’s a really inefficient way to transport heroin around but you have to do it because “powerful forces” (as Iain called them) are trying to stop you from doing it!

I will never forget that example! Anyway, just to explain the background. Consult Hyperion were asked to become part of a consortium bidding to examine the potential for Bitcoin, the blockchain and suchlike across a variety of sectors in response to the Treasury’s decision to allocate £10m in funding for the topic. In this context I (along with a couple of my colleagues) took part in discussion at Imperial that brought together academics, technologists, government and a number of different businesses (including banks), which is why we were listening to Iain.

I thought it would be helpful, with such a mixed group, to use a narrative that would help people to communicate effectively and share ideas. This is why I used the “glass bank” example that I’ve used before and built on the presentation that I gave to the Dutch National Bitcoin Congress in June. As it turned out, it worked very well on the day and after discussing it with a couple of other people I’ve decided to expand it as clients might find it a helpful way to think about the new technology (as they get a bit bogged down in Bitcoin and cryptography). I have to say that it worked largely because Richard Brown from IBM had set things up so nicely for me with his discussion about “Creation Myths and Shared Ledgers” that immediately preceded my talk.

The actual purpose of my talk, narrative aside, was to put forward three solid ideas for research threads that could form part of the project. I’ll blog about this, but I was looking for examples of areas for genuine research, areas where the answers aren’t known, that could complement shared ledger technology in some way to deliver something special or different groundbreaking.

In the end the three examples I settled on were:

Homomorphic encryption. Although I wouldn’t say I was absolutely up to speed on the state-of-the-art in this field I do understand the rudiments and it strikes me as an area where any small improvements could lead to pretty significant benefits. This is an area where pure mathematics is needed and I would’ve thought that most businesses and even technology companies just do not have that kind of research going on.

Publicly-private records. This builds on the idea of “translucent” databases to use homomorphic encryption encryption to put data on public blockchains that can be audited in necessary ways but remain private. I don’t think it’s enough just to store encrypted data on public blockchains. If we can agree on the use of the word translucent to mean data that can be audited while remaining encrypted, then I genuinely do feel that a new kind of financial services industry could be on the horizon.

Bottom-up identity. It occurs to me that if it was possible to use homomorphic encryption to store publicly private records about an individual then the cryptographic techniques that are currently used to demonstrate attributes without revealing them (e.g., interval proofs) might be transformed to help creates a shared infrastructure for identity built on very different foundations (e.g., testing that an age is >18 without decrypting the age).

As I say, these are areas for research. I don’t know what might be discovered in these fields any more than anyone else does, but I have a feeling that it might be both important and of immediate practical application. Now imagine that we bring those technologies together to create “glass institutions” in the financial services world. This would be utterly transformational, in a way that making payments cheaper and quicker (even if this were true) is simply not.

The idea of glass institutions may seem paradoxical but with the advances in technology and our evolving understanding of how replicated shared ledgers might transform a variety of different kinds of systems, I think we can begin to explore their impact. I rather like the language of translucent transactions and I think it works well with the glass bank narrative to open up sensible discussions at the business (and regulatory) level.

So where does this take us? Well, as Richard said in his talk, a replicated shared ledger in financial services is unlikely to be “permissionless” in the censorship-resistant sense that Iain was talking about at the start of the day. However, it is entirely possible and highly desirable to construct replicated shared ledgers that allow for permission and innovation in the use of the ledger even if the ability to create transactions on the ledger is permissioned. Of course, this is not to say that both permissioned and permissionless ledgers cannot co-exist. Michael Mainelli provides an excellent narrative for this perspective, talking about the “Temple of Financial Services” in comparison to the “Souk of Sharing Economies”.

While my heart is with the Souk of Sharing Economies, my head recognises that there may be room for both. A sensible union would be a few, competing, ‘blockchain-type’ services encircling the globe providing end-of-day validation and recording of transactions, while thousands of mutual distributed ledgers do the busy work of serving thousands of shared economies. In effect, the merchants of the Souk bring their ledgers up to the Temple to be validated and timestamped by whichever priests occupy the Temple of Financial Services. It may not be orthodoxy, but it’s not heresy either.

[From iGTB – Liquidity Management – The Temple & The Souk – The Future Of Mutual Distributed Ledgers]

The permission, distributed shared ledger of the Temple will mean disruptive change. I can show this by giving a couple of obvious examples: what if a company chose from a group of regulator-certified auditing applications instead of from a competing group of auditors? Auditing banks’ books would become a continual process and you might even have multiple different applications constantly auditing the same bank on behalf of regulators, shareholders, customers, pressure groups and even rival banks. Anti-money-laundering processes would shift from expensive and rather useless gatekeeping combined with floods of suspicious transaction monitoring to being a variety of different anti-money-laundering applications combing through the shared ledger entries to find transactions indicative of misbehaviour (at which point, law enforcement agencies could apply for warranted access to the unencrypted ledger entry or relevant meta data).

This is why I don’t think it is an exaggeration to say that the shift to shared ledger technologies might be one of the most important innovations of our image of our age, and I will close by making another historical analogy to support that point.

In Victorian Britain, the collapse of railway companies led to a colossal crash in 1866. It was caused (and here’s a surprise) by the banking sector, but in that case it was because they had been lending money to railways companies who couldn’t pay it back rather than American homeowners who couldn’t pay it back. The British government then, as in 2008, had to respond. It suspended the Bank Act of 1844 to allow banks to pay out in paper money rather than gold, which kept them going, but they were not too big to fail and the famous Overend & Gurney went down. When it suspended payments after a run on 10th May 1866 (as frequently noted, the last run on a British bank until the Northern Rock debacle), it not only ruined its own shareholders but caused the collapse of about 200 other companies (including other banks). The directors were, incidentally, charged with fraud but got off as the judge said that they were merely idiots, not criminals.

The reason I choose this example is that railway companies then held the same commanding position in the economy as banks do today, so the impact on UK plc was substantial. Bear in mind that the first railway service in the world started running between Liverpool and Manchester in 1830 and less than two decades later (by 1849), the London & North Western railway was already the biggest company in the world. When the Directors of these gigantic enterprises went to see the Prime Minister in 1867 to ask for the nationalisation of the railway companies to stop them from collapsing (with dread consequences for the whole of the British economy) because they couldn’t pay back their loans or attract new capital, they didn’t get the Gordon Brown, investment bank advisers, suspension of competition law and the tea and sympathy of 2008. Disreali sent them packing as he didn’t see why the public should bail out badly run businesses, no matter how big they might be.

Needless to say, the economy didn’t collapse. As you may have noticed, we still have trains and tracks. A new railway industry was born from the ruins, the services kept running and the economy kept growing. And there was another impact. Andrew Odlyzko’s paper The collapse of railway mania, the development of capital markets, and Robert Lucas Nash, a forgotten pioneer of financial analysis argues that the introduction of basic corporate accounting standards following the collapse of the railway companies was a significant benefit to Britain and aided the development of Victorian capitalism.

So, with the well-worn maxim about not letting a good crisis go to waste in mind, I would like to advance this hypothesis: the long-term impact of the financial crash of 2008 will be a shift to the replicated shared ledger as the central organising principal for financial services. An entirely new way, as Richard Brown notes, of building financial institutions based on common ledgers and APIs.

Francis Keally’s vision will be realised and to the great benefit of society as a whole. After all, you can’t rob a glass bank, even if you work for it.

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