Disentangling digital payments: How blockchain disproved money
This article is derived from my presentation on ‘The future of digital payments’ at CityTech in Milan.
We continuously perform payments throughout the day, at our favourite restaurant, to purchase fuel, to settle a bill. When we speak about payment, it is natural to think in terms of money expenditures. We think payments in terms of transfers of money that allow people to access a desired service or acquire the ownership of certain good.
Payment = transaction
However, what does Payment actually mean? Most surprisingly, Wikipedia explains payment as “trade of value from one party to another for goods, or services, or to fulfill a legal obligation”. This definition seems to ignore entirely the money part and instead concentrates on the concept of trading of value. If we dig deeper and explore further the exegesis of the noun value, we read that it is “a measure of the benefit that may be gained through goods or services”.
Again, no mention of money.
It seems that even from a semantic perspective, the very essence of Payments disregard money almost entirely and revolves instead around another interesting word, which embodies the very act of transferring value: transaction.
Physical vs Digital
The world is slowly moving Payments toward cashless transactions. This transformation has not been as fast as for other markets because the problems introduced by the digitalisation of cash do not offer trivial solutions. A physical banknote, for instance, cannot be spent twice. Once the transaction is completed, the banknote changes hand and the payer has “spent” the available value.
In the digital world, instead, creating assets translates into flipping bits on a memory heap and copying them is nothing more than flipping other contiguous memory addresses in the same way. These are very simple operations, supported by any half decent operating system. For how convenient such digital operations are, they are problematic when applied to a controlled transactional system where value is not supposed to be created out of the thin air, nor copied. The most troubling of these issues is indeed the “double spending” problem, the solution of which triggered the creation of the blockchain technology and the inception of bitcoin and cryptocurrency in general.
Money shot
The very name of cryptocurrency, echoes the concept of a cryptographically-secured valuta. This seems to suggest that economic transactions and the general concept of “money” are indeed related. In actuality, this is a correct assumption but requires a bit of a paradigm shift.
Currency is just the result of a list of transactions on a personal ledger. In that respect, the money we hold in a bank account (the so called balance) is just the result of all the transactions performed by or toward that account that the bank recorded. These transactions are withdrawals (negative sign) or deposits (positive sign). In technical terms, For every debit recorded in a ledger, there must be a corresponding credit so that the debits equal the credits in the grand totals
This way of seeing Money is also true for physical currency, where the banknotes are credits (i.e. a plus on an abstract ledger controlled by the central banks) toward the banknote emitter.
The problem with the centralized digital world, is that the banks, in their role of trusted account-holding third parties, need to constantly reconcile their accounts’ ledger among each others and the central banks. This task is rendered even more difficult by the fact that there is no unified transaction history that could be used in order to check how value has been transferred and spent along the time. In fact, the value backing the entirety of the fiat economic system is based solely on the faith and credit of the economy (!!!). Lastly, due to the so-called fractional-reserve banking, the banks are de-facto allowed to create value out of thin air since they can perform transactions with value they do not own.
The emerging paradigm of universal ledger
The real innovation of the cryptocurrency backed by the blockchain technology is that:
- There is no need to reconcile the ledgers. There is but just one distributed ledger which is kept in synch with the history of all the transactions.
- The amount of value justifying the whole transaction history is known. The initial amount is usually assigned at the start of the blockchain, in the “genesis” block. The rest is “mined” when the transactions are processed
These points are the reason why cryptocurrency transactions are generally orders of magnitude faster than systems such as SEPA or SWIFT, which can take up to several hours, if not days, to complete. With such performances, it is no surprise that the blockchain is viewed as the infrastructural backbone of the next generation technology for financial institutions.
From data ledger to liquid services
If we see transactions as generic exchanges of data, we can go beyond financial trading of value and evolve the concept of ledger into an ethereal distributed database where records are immutable, ordered, public and incorruptible. In its more extreme form, a decentralized and blockchain-powered database wouldn’t need to run on top of dedicated servers but its constituent hardware nodes would be contributed by the network peers. This means that a blockchain DB could run on normal laptops, smartphones and even dedicated hardware that can contribute either storage or processing power or both such as wifi routers, NAS or single board computer.
Using an economic incentive to encourage the community of peers to run the nodes and/or secure the network is the core concept behind cryptocurrency, where data-related value in the form of application-specific tokens is distributed to the contributing peers. Such tokens are essentially the fuel powering the ecosystem. The capability of trading them with other service tokens or even fiat currency in a way non dissimilar than the forex market provides the unprecedented property of liquidity to the services they relate to.
Admittedly, the technology is experimental at best and far from the reliability needed to implement non-trivial applications with production-grade quality. We can however imagine the future of payments evolving more and more into value-backed data exchange where the boundary between fiat money and application usage is blurred by the intrinsic liquidity of the services deployed on community-powered systems.
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