Blockchain Challenges

There have been a few different startups trying to create basically their own blockchains with specific use cases. In our view we feel that kind of defeats the purpose of having a network itself because it just recreates silos.

Tim Swanson, head of research at R3CEV

As the blockchain ecosystem evolves and different use cases emerge, organizations in all industry sectors will face a complex and potentially controversial array of issues, as well as new requirements. With blockchain, we can imagine a world in which contracts are embedded in digital code and stored in transparent, shared databases, where they are protected from deletion, tampering, and revision. In that world, every agreement, every process and every transaction would have a digital record and signature that could be identified, validated, stored and shared. Intermediaries like lawyers, brokers and bankers might no longer be necessary. Individuals and organizations would freely transact and interact with one another seamlessly. This is the exciting future blockchain promises.

Actually, almost everyone has heard the claim that blockchain will revolutionize business and redefine companies and economies. Nevertheless, some fintech experts worry about the hype. It’s not just security issues that concern them. If there’s to be a blockchain revolution, many barriers (technological, governmental, organizational) will have to fall. Here we consider some of the most imminent challenges faced by the blockchain industry today.

Regulation and governance

Lack of relevant legislature leads to uncertainty on numerous issues. The technology must comply with requirements (e.g., of the state) to gain trust, but no requirements — no compliance.

Regulatory entities often drag technology innovations backwards, and that’s certainly the case with blockchain. New products and services are evolving based on blockchain transactions, but there are currently no regulations on how these transactions should be carried out. Although auditability and transparency are expected benefits of blockchain, highly safety-sensitive industries may need to develop new regulations for blockchain. Its distributed ledger transactions are likely to drive changes in industry regulations governing financial reporting as well as auditing processes. Information disclosure regulations will likely need to be amended to protect companies as well as their investors and customers. Furthermore, laws will need to be issued to control blockchain’s smart contracts.

As long as blockchain’s governmental challenges are not resolved, its potential cannot be fully realized. Because blockchain protocols offer an opportunity to digitize governance models, and because miners are essentially forming another type of incentivized governance model, there have been lots of opportunities for public disagreement between different community sectors. These disagreements are a notable feature of the blockchain industry and are expressed most clearly around the question or event of ‘forking’ a blockchain, a process that involves updating the blockchain protocol when a majority of a blockchain’s users have agreed to it.

Increased transaction costs

It is believed that thanks to blockchain, multiple parties can conduct transactions seamlessly, without paying a commission. However, the cost savings are dubious. Some experts say that moving cash equity markets to a blockchain infrastructure would drive a significant increase in the overall transaction cost. Trading on a blockchain might also be slower than traders would tolerate, and mistakes might be irreversible, potentially bringing huge losses.

In general, a distributed ledger system is more costly to operate than a centralized system, as higher computing power is required. For example, Bitcoin currently has considerable transaction costs after being advertised as ‘near free’ for the first few years of its existence. As of late 2016, it could only process about seven transactions per second, and each transaction cost about $0.20 and could only store 80 bytes of data.

Network size

Blockchains, like all distributed systems, are not so much resistant to bad actors as they respond to attacks and grow stronger. This requires a large network of users, however. If a blockchain is not a robust network with a widely distributed grid of nodes, it becomes more difficult to reap its full benefits. But implementation of a nascent technology requires a comprehensive reconstruction of a huge system with myriad participants, each of them carrying certain risks and expenses. Some (such as clearing and settlement units of exchanges) consider blockchain a threat, while others, though seeing potential benefits, are not willing to rush in.

Data privacy

There is no solution to the user privacy issue as yet in the blockchain. Initially, it was ensured by nicknames (in the case of Bitcoin). However, when blockchain is used for any purpose except cryptocurrency exchange, it turns out to be too transparent. This is the crucial stamping block for blockchain’s introduction into banking operations. Recently, it was suggested that off-balance deposits could be conveniently handled through the blockchain technology, but, nevertheless, it can hardly be implemented as is, because all banks would know each other’s clients. And that would be a breach of bank secrecy.

One of the key benefits of blockchain is that once data is stored, it cannot be altered (at least, not easily). This clearly has implications for data privacy, particularly where the relevant data is personal data or metadata sufficient to reveal someone’s personal data. Besides, the unique transparency of transactions on the blockchain is not easily compatible with the privacy needs of the banking sector: the use of crypto-addresses for identity is problematic as no bank likes providing its competitors with precise information about its transactions, and the bank secrecy is required by law.

Like any emerging technology, blockchain will evolve. It has the potential to become an integral part of the operation of many businesses, offering scalability, security and computing power. But, of course, as with most new technological service offerings, there are a number of risk-based issues that need to be carefully considered before businesses can start to fully realize the potential benefit. So, when your company considers applying blockchain to add new value to your business, make sure you allow the business to drive the investment.