The Blockchain: ‘Just Like the Internet,’ Except That It’s Not

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“It’s just like the Internet.”

And so starts every conversation by the devoted that rationalizes why bitcoin and the blockchain is the technology that will forever change how financial services and payments happen around the world.

And why if you don’t agree, you are (a) a complete moron and (b) anti-innovation.

I had this experience at a panel I participated in last week at a conference filled with bankers eager to understand the details of bitcoin and the blockchain. For the true believers, I’ve discovered that it’s simply impossible to have a rational conversation about the pros and cons of the blockchain. Why? Because it’s impossible to move them away from the narrative about how it is just like the Internet when it started in the 1980s. This, of course, is all just cheap talk because it immediately moves the discussion away from just how the blockchain could generate value.

Described as “owned by no one,” and a glorious libertarian bastion of permissionless trust, the devoted use the analogy of bitcoin and the blockchain as one that is identical to the physical Internet — a global network based on nothing but protocols that move data all over the world in real time without any central authority telling it how and what to do.

There’s only one problem with that narrative. It doesn’t accurately reflect how the physical Internet really works or even how it got started, or how bitcoin and the blockchain really work now and are likely to in the future.

There’s another problem. Lots of really smart people in financial services are drinking that Kool-Aid served by the devoted in massive quantities.

And, that’s scary – not because bankers are eager to find ways to innovate how money and data moves around the world – the one great thing that the blockchain has done is to start those very necessary conversations. Scary because banks are prioritizing money and people and resources against a set of blockchain initiatives that they believe can deliver innovation as powerful and game-changing as “the Internet was in the 1980s.”

So, I thought it might be time to set the record straight.

Here are the five things that are important to understand about the blockchain, the Internet and how it started, and the implications to innovation in financial services.

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Bear with me for a couple of hundred words on how the Internet got started and how it works.

The physical Internet – the backbone that enables the delivery of messages and data between the billions of senders and receivers worldwide today — was developed by ARPANET in the 1960s. ARPANET is the acronym for the Advanced Research Projects Agency Network that was funded by the U.S. Department of Defense. The purpose of the network – and the funding – was to develop an alternative to the circuit networks that existed at the time – a network that could send packets of data along a physical network that didn’t need connections at each send/receiver endpoint in advance of data being sent. Part of the initial work of ARPANET was to define standards for how those messages would be sent across network nodes. Those standards, or the Internet Protocols we know as TCP/IP, were created in 1982.

Up until the late 1980s, the physical Internet was private and connected only a few dozen research centers and universities, mostly in support of government-directed projects. At about that time though, providers that could enable connections to the physical Internet – called Internet Services Providers or ISPs – emerged to serve what was beginning to become a more commercial use of that physical Internet. The physical Internet was fully opened to commercial traffic in 1995.

Even in its early days, when the network was a couple of dozen research labs, including MIT here in Boston, a handbook with rules and guidelines for its use was developed and circulated. Here’s one of its passages:

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“It is considered illegal to use the ARPANET for anything which is not in direct support of Government business … personal messages to other ARPANET subscribers (for example, to arrange a get-together or check and say a friendly hello) are generally not considered harmful … Sending electronic mail over the ARPANET for commercial profit or political purposes is both anti-social and illegal. By sending such messages, you can offend many people, and it is possible to get MIT in serious trouble with the Government agencies which manage the ARPANET.”

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Fast forward to today. The physical Internet backbone that carries data between different nodes on the network is now the job of a number of companies called Internet Service Providers (ISPs) which include companies that provide pipes over long distances, sometimes internationally, regional pipes, and local pipes that ultimately connect into households and businesses. Connecting to the physical Internet can only happen through one of those ISPs, players like Level 3, IBM, Cogent and AT&T. Every ISP operates its own network. Internet Exchange Providers or IXPs, owned by private companies and sometimes by governments, make it possible for each of these networks to be interconnected and for messages to move across the entire network. Many ISPs have contracts with the providers of the physical Internet backbone providers to deliver Internet services over their networks to the “last mile” – the consumers and businesses that want and get Internet connectivity. The Internet protocols followed by everyone on the network make it possible for data to flow without interruption to the right place at the right time.

So much for the Internet 101.

This Internet, however, is not governless. There are, in fact, 4 governing bodies that provide oversight of the Internet’s rules and infrastructure: The Internet Society (standards, policies), The Internet Engineering Task Force (working groups that look after the Internet’s infrastructure and tackle big issues like security), The Internet Architecture Board (protocols and standards), and The Internet Corporation For Assigned Names and Numbers (ICANN – manages the domain name system).

While none of these organizations “owns” the Internet, together these governing bodies determine how it operates and set rules and standards that everyone abides by. Contracts and the legal framework that underpins all of that is in place to determine how things work and what happens if something goes wrong. To get a domain name, for example, one needs permission from a registrar that has a contract with ICANN. To connect to the physical Internet, ISPs need contracts with the Internet backbone providers, and IXPs have contracts with the Internet backbone providers to connect to and with them. Concerns over security issues? A working group is formed to work on the problem and the solution developed and deployed is in the collective interest of all parties.  If your Internet is down, you have someone to call to get it fixed. If the problem is at the ISP, they, in turn have contracts in place and service level agreements that govern how those issues are resolved.

The U.S. “Controls” The Internet

For all intents and purposes, the U.S. has held the keys to the “control” of the Internet of for the last 20 years. ICANN is a private entity created in 1988 by the Department of Commerce to determine who gets a domain name on the Internet. ICANN and the domain name structure makes it possible for you to find PYMNTS.com by typing in pymnts.com rather than a string of numbers that is our IP address.

Over the years, there has been growing criticism over having the U.S. control such an important part of the Internet. In response, last year, President Obama said that the U.S. would relinquish control of ICANN in 2015. Proposals for governance in the years beyond that included the formation of a UN-esque group consisting of stakeholders in industry, governments, academia and standards groups that would work under a contract with ICANN or, as China and Russia suggested, giving the keys to the United Nations.

Almost immediately, there was global uproar over fears that in the wrong hands, the Internet would be censored or risk falling into the hands of a single group that might do bad things.

Just recently, it was decided that the U.S. would continue to govern ICANN through September 2016, with the option to renew its contracts another three years – enough time for a new governance model (if there is to be one) can be worked out.

All this is to say that the Internet is anything but the Wild West that runs itself. It didn’t start that way, and it doesn’t operate that way today. And, no one is talking about making the Internet governless; they are talking, in fact, about precisely who and how it should be governed.

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That, however, is not the state of affairs in the blockchain community today. And that should freak a lot of people out.

The blockchain is a technology that is used to continuously record every bitcoin transaction that takes place. It is a distributed database or public ledger that updates itself every 10 minutes. This distributed database is operated by miners whose only qualification to become a miner is that they have the money to buy and maintain the super computers needed to process transactions every 10 minutes. That actually costs a lot of money. When data moves across the blockchain, it is wrapped in a sliver of bitcoin that is the miner’s compensation.

When bitcoin was $700, $800, and $1,000 each, going to $100K and even $1M a couple of years ago, miners had an economic incentive to invest in equipment to increase processing speeds, and innovate. Today, with bitcoin in the low $200s (where it’s been for the better part of the year), the incentives are not as strong for the miners to make those improvements. One of the biggest technological criticisms of the blockchain technology as it exists today is that it is too slow to accommodate the volume of transactions that it would need to carry to function as a global network. To improve these systems, the miners have to invest and it is entirely up to them individually as to whether – and how – they will, if they will.

But the other, more concerning aspect of the blockchain is that it is truly governless. No one can tell miners to upgrade, slow down, speed up, stop or start or do anything. And, that’s something that the devoted claim as a badge of honor, and say is identical to how the public Internet operates. But as you now understand, the public Internet has governance and rules and standards that govern how it operates and did from Day 1. The blockchain has none of that.

The closest thing to governance is the Bitcoin Foundation, which does not exactly have a sterling reputation – three of its five board members are pretty sketchy characters. Mark Karpeles, the head of Mt. Gox, one of the biggest mining operations out there before it went bust – is now in the custody of the Japanese police. You might recall that a lot of bitcoin mysteriously disappeared from Mt. Gox – bitcoin that is yet to be found. But beyond that it doesn’t really have a lot of power to govern anything even though it would like to. Speaking of miners, there is also a small number of miners that control a large portion of the blockchain activity, none of whom are known. That has raised concerns among many about the potential risks of so much concentration of processing power in so few unknown, unregulated, ungoverned entities.

But the comeback, of course, is that the ledger is public and transparent so the risk of losing money attributed to activity on the blockchain is minimal. Yeah, tell that to the people who are still looking for the money they lost in Mt. Gox and the several other high-profile bitcoin thefts over the last couple of years.

Also keep in mind that two of the biggest “selling points” of the blockchain are its irrevocably and anonymity. Irrevocable and anonymous both have big and sharp double edges in an unregulated financial services world. Today, if there’s an issue with a financial transaction, there is a person to talk to, an entity to stand behind it and a legal framework – if need be – to resolve any problems. None of that exists today in the world of the blockchain, which makes it very, very different from how the Internet started and how it grew.

Suddenly, unregulated, governless, standardless, and a system in which anyone with enough money to set up shop entry criteria doesn’t look like the kind of structure we want to underpin an innovation that moves trillions of dollars of money around the world every day.

But in any case, the blockchain isn’t like the Internet at all.

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There is a however, here.

One must separate the technology that is the blockchain – the notion of a distributed ledger that can become the foundation for a new set of rails that efficiently move information and money around the world – from how it is implemented today – governless, unregulated miners that rely on an unregulated global digital currency as payment.

Unfortunately, the great difficulty today in having any conversation with the devoted on this point is that they cannot separate bitcoin from the blockchain. For any of these ideas to get any serious traction in the boardrooms of financial institutions and payments companies, that needs to happen.

Which is why you are starting to see initiatives pop up like Ripple and its  partnership with Earthport, Citi with its distributed ledger experiment, and Token, which uses banks as its “distributed ledgers.” But regardless, for the blockchain as an alternative technology to succeed as a new set of “rails” for moving money around the world, there needs to be governance and standards put in place to protect the assets that are moving through it and the institutions and people who will rely on it.

And, in my opinion at least, an imperative to separate the bitcoin from the blockchain.

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Speaking of bitcoin, I actually thought that we, as a financial services ecosystem, had given up on the notion of bitcoin as an alternative global currency. Yet I continue to be amazed at how many people still think that it has some promise or potential. It doesn’t.

It does not solve a single problem that anyone, anywhere has – unless you are a criminal and need an anonymous currency to pay or be paid. That is bitcoin’s most prevailing use case. It’s not a substitute for cash digitally, and it’s not a solution for developing economies. There is no business case anywhere for a global currency that usurps any central bank authority to manage its fiscal policy through the use of its currency. Absolutely none.

It also not a cheap alternative to Western Union, which is the other narrative that the devoted love to latch onto. In another case of “sounds great but doesn’t work in the real world,” what everyone conveniently forgets is that sending someone bitcoin is only as good as their ability to spend that bitcoin. And that is only as good as acceptance of bitcoin. And in case you haven’t noticed, there aren’t a lot of places that accept bitcoin anywhere in the world. Just ask the many people who’ve tried to travel the world and live on it.

In developing economies, people conduct commerce one way and one way only – cold hard currency. And, if you need proof of that, look no further than M-Pesa which is only now, some eight years later, becoming accepted as a method of payment at some merchants, but which got off the ground because people could go to agents and get cash to spend. In developing countries, there is simply no way that these cash-intensive economies could transition to bitcoin any time soon. That is why the e-money providers like M-Pesa spend so much money and effort building cash-in/cash-out networks. It’s not because they are stupid and don’t like technology. It is because they are faced with the reality of living in impoverished countries and not hanging out in upscale coffee shops in San Francisco.

Here’s more proof that bitcoin as a method of conducting commerce is on life support. Bitpay, one of the largest and most well-funded bitcoin processors, reportedly laid off most of its remaining employees last week in an effort to “keep pace with bitcoin’s growth.” Which, based on this news, seems to be moving in the wrong direction.

So, can we agree to move time, energy and brain cells away from bitcoin as an alternative currency? And to disentangle the technology of the blockchain away from it, too?

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Permissionless trust is another concept that the devoted tout as the blockchain’s crowning glory.  Permissionless means that anyone with the cash to set up shop can become a miner – all that is needed is to provide a proof of work to the blockchain. Applied to today’s financial services industry, that would be the like saying anyone with the cash to build a new network and send proof of receipt of money each time money moved could do so. Probably not the way we want to run our financial services networks.

But here’s where permissionless works and works amazingly well – in inspiring innovation.

No innovator needs permission from anyone to come up with good ideas and bring them to life – provided they can get access to capital and operate within the regulatory boundaries that exist. And, that philosophy has contributed to the development of thousands of new ideas – some which have become blockbusters, others that have died public painful deaths,  and many, many others that are chugging along. In the U.S. we have the most vibrant permissionless environment of innovation that exists anywhere in the world and the infrastructure and capital and regulatory frameworks to support – not stifle  – its continued growth and vibrancy.

That’s why one of the best things that has emerged as a result of the ongoing narrative about the blockchain is how to apply new technologies to removing the frictions from processes that exist today and modernizing the systems that power our global banking and financial services systems.

There’s also nothing wrong with having, as that inspiration, some of the greatest innovations of our time – like the Internet. It’s just better when that’s done with eyes wide open to the facts of how it all happened.

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