Blockchain technology: Redefining trust for a global, digital economy

This post is co-authored with Mariana Dahan,* The World Bank

It seems everyone is talking about blockchain and distributed ledger technology. Google Trends data show that searches for the word “blockchain” have exponentially increased. News articles tout the blockchain’s unique “digital ledger technology” as a solution for everything from bypassing Wall Street’s rent-seeking middlemen to reforming developing-world democracy.

A good deal of this could be hype. But the blockchain is a major breakthrough. That’s because its decentralized approach to verifying changes in important information addresses the centuries-old problem of trust, a social resource that is all too often in short supply, especially amid the current era’s rampant concerns over the security of our personal data, our finances and our transactions. It turns out that fixing that can be a boon for financial inclusion and other basic services delivery, helping to achieve the global objectives laid out in the Sustainable Development Goals (SDGs.)

Sorting out hype from reality may depend on how well we identify where institutions that have until now played a role in mediating trust between people are falling short, especially in the key area of money. Deploying the blockchain in those settings to generate secure, decentralized trust could achieve great strides in inclusion and innovation.

What do we mean by decentralized trust? The concept is unfamiliar in part because its converse — centralized trust — is something that we often take for granted, at least while it’s working. But if we look at the history of transactions since the early barter systems to modern-day digital money exchanges, we can see how different trust protocols have evolved and how, in each case, centralizing trust within particular institutions has periodically caused problems.

As strategies for dealing with this challenge evolved, different trust bearers emerged. Charting that evolution, we can also see parallel changes in the tokens that encapsulate mediums of exchange and stores of value. Societies’ systems of trust, in other words, have always been intrinsically linked to their definitions of money.

Financial transactions: trust bearing and encapsulating of the value of money throughout history

Tribal chiefs were the first trust bearers, acting as de facto guardians of the collective memory, which “recorded” tribe members’ exchanges of value. But one or several tribe members’ memory was not enough to track the multitude of transactions over time. People then introduced tallies and other early registers, such as the nick-sticks of the King of England, to help overcome the issues of tampering and to act as bookkeepers.

Later, governments issued money backed by diamonds and precious metals, especially gold, to encourage trust in the monetary system. These commodities were scarce, ensuring they retained their value, and also had the advantage of being easily transportable and divisible. This practice has since been supplanted by the issuance of fiat money without the backing of a physical commodity, a shift that has left adherents of the gold standard uncomfortable to this day. In essence, they don’t trust the government guarantor to maintain the value of the currency.

The age-old debate over gold cannot be divorced from the outsized role that commercial banks have increasingly assumed within our monetary system, a shift that altered the composition of money and gave them a key record-keeping function as delegated trust bearers. As banks recycled deposits by issuing claims against them in the form of checks and promissory notes, fiat government money was transformed into a wider circulation of credit/debt money. That left banks occupying quasi-independent nodes in a dispersed and fragmented network of ledger-keepers.

This created a difficult balancing act as the assets side of the banks’ ledgers were illiquid, since long-term loans could not easily be called, while their liabilities were very liquid, since depositors could call their funds into cash at any time. Public trust in banks’ management of that relationship became a vital social good whose frequent breakdown gave rise to banking crises. That led to the creation of central banks, which offered lender-of-last-resort services in return for regulatory scrutiny. A hub-and-spokes structure emerged, with a centralized ledger managed by the central bank acting as a trust backstop for the multitude of subordinate commercial bank ledgers, where most of society’s monetary balances remained.

This centralized trust model, with its siloed information pools, has since been digitized. But its structure hasn’t changed. And, even with central banks doing their darnedest to manage the core problem of mismatched assets and liabilities, the systemic relationships between banks’ independent and closed ledgers has become extremely hard to manage as the system has become more complex and interconnected. (The 2008 financial crisis is best viewed as a breakdown in public trust in the ledger-keepers.) Meanwhile, hacking attacks against banks, such as those which recently allowed criminals to exploit the international exchange messaging service Swift show that these big repositories of data remain vulnerable.

This is where the blockchain and distributed public ledgers come in. We now have the prospect of supplanting those risk-laden trust bearers with a more robust, decentralized model. This kind of ledger, shared among a network of autonomous computers, which confirm and validate its content by following a unique algorithm that compels them to act in the common interest, is essentially tamper-proof. The cryptographic protections are such that, under current computing capability, to go back and change past data entries would require a prohibitively expensive amount computational power. That’s why it’s often described as the world’s first “immutable ledger.” This makes for safer monetary transmission and for a more or less permanent record of digital money transactions.

Money might be just the start of it. The topics discussed at this past week’s Blockchain Summit on Necker Island in the British Virgin Islands reveal a dizzying array of non-currency use cases for the technology: Some are working on real-time transfers of stocks and bonds, bypassing the financial intermediaries that currently engage in a convoluted chain of clearing and settlement procedures. Musicians and photographers are storing ownership data about their digital works on the blockchain to gain autonomy over their copyrighted material and build direct, creative relationships with fans and other artists. Retailers are using the blockchain to turn loyalty points into a de facto currency. Hospitals are trying out systems that give patients control over their personal records while opening encrypted versions of them in aggregate form so that research can be done on the data. The blockchain’s disintermediating potential is being tried out in trade finance, supply chain management, auditing, voting systems, notary and legal services, and the big one, digital identity.

Just as importantly, blockchain technology will facilitate the future that technologists, governments and businesses are already planning for. Many believe the Internet of Things (IoT), in which potentially hundreds of billions of devices will transact and share information across a complex array of communication lines, will be insecure and inefficient unless it’s built on a blockchain structure. It won’t be cost-effective for banks to manage these billions of tiny transactions, and while device makers, software providers and telecom companies may want to position themselves as intermediaries for these exchanges, it’s not clear how they would be able to interoperate with each other. As a group of IBM engineers noted in a paper launching a blockchain-based program for the IoT economy, such a decentralized system is needed to “save the future of the Internet of Things.”

As an extension of this IoT issue, the blockchain may also be needed to secure the distributed, decentralized power grids that communities around the world are building in the interest of energy efficiency and security. The new grids will be based on complex IoT networks in which interlinked home-based solar energy cells; autonomous, auto-communicating smart meters; and locally based electrical devices are all exchanging information, electrons and money with each other. It’s the antithesis of the old centralized model, where a public utility is trusted to deliver the power, monitor and manage each home’s meter, keep track of how much customers use and owe, and then invoice everyone. Public power utilities will have no economic stakes in those localized transactions, and so can’t be tasked with monitoring the data and sending out invoices. Instead, this future energy infrastructure needs a decentralized trust protocol and a digital currency that can seamlessly flow between devices at low cost. Blockchain technology is the prime candidate for providing both.

So, what of economic development and those SDGs? Well, as distributed ledgers overhaul the legacy banking processes, the hope is that developing-world financial systems can leapfrog to the next generation. This has parallels with the leapfrogging that billions of developing-world people did when they gained access to mobile phone services well before they had landline telephones.

Perhaps the biggest promise in this evolution of trust protocols and digital money is that it might advance financial inclusion. The blockchain has the potential to offer a less cumbersome, less expensive infrastructure for sending money, which could finally make it cost-effective for financial institutions to service the poor. If this technology can also be used to secure robust, self-sovereign digital identities around personal data, there’s a real possibility that people in places with poor documents, registries, and rules of law can finally establish trusted measures of their otherwise good reputations. This would allow them to assert who they are and show why a bank should give them a loan.

Meanwhile, the prospect of storing and updating property title and cadasters on the blockchain could for the first time allow the poor to assert reliable title claims to their homes and use them as collateral for borrowing. Similarly, if small and medium-sized enterprises could irrevocably prove ownership of business and commercial assets — e.g, equipment, livestock, inventory — they could gain access to working capital and, by extension, to a much wider, global marketplace.

Now for the caveat: the implementation of this technology will, like all new technologies, come with major costs and challenges. It could mean massive layoffs, this time in services sectors such as law and accounting. There’s also a “garbage-in” risk that the information that’s input into a blockchain isn’t accurate, creating a permanent ledger of faulty data. Finally, the immutability and irreversibility of transactions might make it harder for individuals and firms to arbitrate solutions whenever there’s a dispute.

Then there’s the question of which blockchain model to use.

The bitcoin blockchain is the most established, valuable public blockchain that’s free from any trusted authority’s control. In theory — and in practice, so far — that makes it the most robustly tamper-proof. But it has its limitations: an open-source governance structure makes it hard to make contentious changes to the operating algorithm; the transaction-processing capability needs to be significantly increased if blockchain uses are to be expanded beyond pure bitcoin currency payments; its anonymity features, while strengthening decentralization, do not fit comfortably with society’s identity-focused legal system; and bitcoin’s massive, “permissionless” network of autonomous transaction validators (know as “miners”) uses an inordinate amount of electricity.

Some are now looking at alternative models of private, or “permissioned,” blockchains, which distribute a shared ledger across many nominally independent computers according to the authorization of some trusted entity. That makes for a more efficient, easily governed system, but it inherently reintroduces some of the risks associated with centralized trust bearers and limits the amount of freewheeling innovation that can occur on such platforms. When it comes to the financial system in particular, there’s a strong case to be made for a decentralized model that’s not controlled solely by banks. That way we avoid entrenching the systemic risks of the current infrastructure. We don’t want a too-big-to-fail blockchain.

The good news is that amid the rapid pace of open-source “fintech” innovation, multiple solutions to these challenges are being explored. It’s hard to imagine that distributed ledger technology isn’t coming, one way or another. When it arrives, the impact on society could be profound. It is therefore critical that governments engage their citizens and each other in serious discussion about the underlying trust infrastructure of 21st century digital society.

In some cases, we may discover that it’s best to stick with centralized trust bearers, especially if their existence is integral to the bonds on which our communities are formed. But in many other situations, we may find we’re better off investing trust in an algorithm that manages shared information across a decentralized network.

It’s too early to know the answers. That’s why it’s incumbent upon all of us to study and understand how to maximize the benefits of this technology. With serious research, we can discover the best ways to use it to lower costs and increase access to financial services while protecting the social capital that’s vital for economic development. Society must make swift changes that accommodate the demanding nature of these new models, keeping in mind the unprecedented competition and challenges facing incumbent financial institutions and regulators. If we get this transformation right, and do so in a collective, collaborative manner, it could provide a vital building block for achieving the international community’s SDGs.

* Mariana Dahan is the Senior Operations Officer in the Office of the World Bank Group’s Senior Vice President in charge of the 2030 Development Agenda, United Nations Relations and Partnerships. Dr. Dahan holds PhD degrees from ESCP Europe Business School and Paris II University in France. Prior to joining the World Bank Group in 2009, Dr. Dahan was a visiting researcher at the MIT Sloan School of Management in the U.S.