Most blockchain ideas that I hear about make no sense. In general, they do not involve blockchains (just some sort of shared database) and where they do actually involve blockchains they are used to emulate shared databases to deliver a slower and more expensive service. How is it then that even a blockchain grouch such as me thinks that the technology has something to offer?
Well, first of all, let’s stop talking about blockchains and use the more general terms shared ledgers to cover the spectrum of relevant technologies and enterprise shared ledgers to cover the particular use case of sharing data between organisations (and regulators etc) in a permissioned manner.
I think that the use of enterprise shared ledger (ESL) software will transform business more than enterprise resource planning (ERP) did a generation ago.
Consider the recent case study of Wirecard. The auditors reported that the company was solvent because they thought that there were bank accounts with billions of euros in them. It turns out that there were not. What a simple problem to solve! If only there was some form of immutable record of transactions that companies could use to store account balances digitally-signed by their banks that investors, customers, suppliers and regulators could use instead of auditors to determine that the assets of companies exceed their liabilities! Transparency is a route to trust.
Helen Holmes (Instagram @TheOfficeMuse).
Now, some of the information in such a shared ledger is confidential: it should only be accessed by the regulators, the companies involved in the transactions and perhaps the market where the transactions take place. Therefore we need mechanisms to exploit the beneficial transparency of the shared ledger in such a way as to preserve necessary privacy. Let’s use the term “translucent” to illustrate the case where observers could look through a list of (for example) bank deposits and loans to check that the bank is solvent, but not be able to see who the depositors or lenders are.
Does the technology to implement such translucent transactions exist? Actually, it does and it’s not new. Many years ago Eric Hughes, author of the famous cypherpunk’s manifesto of the early 1980s, wrote about “encrypted open books”. This is an idea that now seems fantastically prescient, a perfect example of what I’ve previously labelled counterintuitive cryptography. It is founded on the use of what is known as “homomorphic encryption” to store records in a form where they can only be read by authorised parties but can nonetheless be subject to some basic computation while still encoded. In other words you can determine that (encrypted 2) + (encrypted 2) = (encrypted 4) without ever being able to read the “2” or “4” .
This means that you can prove certain assertions about data without ever revealing what the data actually is. One obvious use of this, and as far as I can remember this was central to Eric’s discussion of the topic, is to take a list of the encrypted assets of the company together with a list of the encrypted liabilities of the company and compute that the company’s assets exceeds liabilities. Thus you can, essentially, audit that the company is solvent without being able to read what any of the assets and liabilities actually are.
(When you combine the idea of open book accounting with Ian Griggs’ idea about triple entry accounting that dates from around the same time, you can see the basis for a new and more efficient financial infrastructure that is simultaneously the doom of auditors everywhere. There is a very comprehensive review of the origins and taxonomy of the intersection between open book, triple-entry and shared ledgers in a paper from Juan Ignacio Ibañez, Chris Bayer, Paolo Tasca and Jiahua Xu.)
The use of translucent transactions means that markets and regulators will no longer need to wait until the end of the reporting period to conduct an audit and produce the results with the help of skilled financial professionals. Instead we will find ourselves in an era of ambient accountability, a term that I borrowed from architecture to describe a transaction infrastructure that delivers constant verification and validation. It describes perfectly how a shared ledger can transform business.
If you want to check whether a bank is solvent before you deposit your life savings there you will do it using an app on your smart phone not by looking at a year old auditor’s report covering some figures from the year before that filtered through levels of management.
Since regulators will be able to see the state of the ledger at all times, they will be able to spot unusual or inappropriate activity. What’s more, the information stored in the ledgers in encrypted form has been put there by regulated institutions so should there be a need to investigate particular transactions because of, for example, suspected criminal activity then the law enforcement agencies will be able to ask the relevant institutions to provide the keys necessary to decrypt specific transactions.
(If you are interested in learning more about ambient accountability and translucent transactions, I wrote a paper for the Journal of Payments Strategy & Systems in Summer 2016 with Salome Parulava and Richard Brown, who is now the CTO at the leading ESL software provider R3. R3 recently released their Conclave product that takes an interesting step in this direction, allowing organisations to exploit Intel
I can see that ambient accountability and translucent transactions give business a means to provide a kind of controlled transparency that will be a competitive advantage of interest to all stakeholders: as an investor, as customer, as a citizen, I would trust these organisations far more than “closed” ones. Why rely on management assurances of business activity when you can see how their purchase ledger is looking (without necessarily seeing what they’re buying or who they are buying it from)?
A market built up from what I like to call “glass organisations” trading with each other with ERPs linked through ESLs, serving stakeholders and working with regulators in entirely new ways is a very attractive prospect. In particular, it suggests that a new and better financial market infrastructure may be on the horizon and that the lasting impact of the blockchain will be to create new kinds of markets and therefore new kinds of institutions, a subject I will return to in a future article.
BERLIN, GERMANY – NOVEMBER 19: Markus Braun, former CEO of German digital payments processor … [+]
In this world, whether it is Wirecard, Enron, Tether or anyone else, nobody will be required to rely on the word of auditors because they can simply calculate for themselves whether the company is solvent or not. No more relying on tips and whispers to find out whether the money in some remote bank account is sufficient to cover the liabilities in other jurisdictions: cryptographic proofs will replace auditing and apps will replace auditors.