Bitcoin in the Fog of War. Part II

In the Part I, we examined condition known as the “fog of war” and its effect on Blockchain and crypto adoption process. The goal was to gain clarity in understanding the complex reaction of world financial establishment to the evolution of this disruptive technology and its nascent digital asset class — cryptocurrency. In Part II , I would like to narrow our focus on the heart of the banking industry — its core banking systems.

There is a tremendous push toward transaction banking — every bank now wants to facilitate online payments (bill payments, cross boarder remittance, diaspora accounts, e-merchant accounts etc.) All push to become a player in multi trillion-dollar e-commerce market. Russia’s Sberbank had invested $500.87 million into e-commerce joint-venture with Yandex.Market. In China, for example, ICBC (the Industrial and Commercial Bank of China) has a site that is one of the leading online shopping malls.

Recent years have brought strong growth in credit cards transaction volumes in Emerging Asia (76.1%), CEMEA (13.6%), and North America (8.7%), respectively. During the past 10 years, debit-card-to-credit-card ratio shifted from 59:41 to 90:10 as a result of Basel III and credit policy changes. During the coming years, credit cards transaction volumes are expected to be affected by the interchange fee cap in Europe, rising costs of credit card issuance, and the reluctance of banks to issue credit cards in an uncertain economic environment. Those economic areas, deemed “uncertain” by the banks, will present perfect growth opportunities for alternative payment systems.

As previously pointed out, current banking transaction ledger was developed by the Medici double entry accounting process in the 14th century. The modern financial system is simply a network of these ledgers held at each bank. Behind often modernized UI interfaces and mobile apps, and at the heart of a bank lies its core banking system. Often decades old and running on mainframes (Hogan), this software is responsible for handling much of a bank’s operations; such as processing deposits, payments, loans and other transactions. Historically core-banking solutions have been high-risk and services heavy implementations. According to Cognizant, 25% of core-banking projects fail. Proprietary data models often designed around banking products restrict organizational ability to re-engineer their businesses and deliver new experiences. A recent study by BusinessInsider points out, that legacy core software systems, implemented decades ago, are letting banks down, and replacing old systems, or “overhauls,” is becoming increasingly necessary. In short, one might say that eventually growing demand on existing legacy core banking systems will force them to abandon 600-year-old system and evolve.

So, why is there so much resistance in accepting the new technology which promises cheaper transaction costs? What does it really mean: “Blockchain is not Bitcoin”? Why the latter is being treated as “clear and present danger” by the fiat world? Well, the obvious reason for such hostility could be the mandate for digital asset such as Bitcoin — crypto is a precise, sharp instrument with sole purpose to facilitate disclosed by smart contracts obligations without middle man, without the involvement of a central institution.

Thus, one might say BTC was born to disrupt and eliminate fiat. It is at this juncture; the fog of war becomes the thickest. Let’s look at some most prominent statements made by both sides of the barricades.

Speed — more precisely Transactions per Second (TPS).

We often hear that VISA/Master card network is capable of 24K + TPS and Bitcoin is just too slow with only 7 transactions per second. I do not want to debate exact numbers based on the latest developments, forks and different cryptos, because this is not the issue. What is interesting is that Alibaba (AliPay) on its Single’s Day this year had a 27% increase at $30.8 billion compared to 2017 sales which demanded close to 300K transactions per second at peak. This presents a question — how is this possible? Do they not use VISA/Mastercard network which should limit them to much lower TPS? Well, one of the explanations is the type of transactions which were facilitated.

A few years back, our company was hired to develop a stress test harness to measure TPS benchmarks for one of the US largest online payment gateways. This was a cloud migration and scalability on demand was evaluated. Smart approach is to validate as much as possible on client side to minimize the load on the servers. However, even among transactions passed to the server there is a difference; simple card validation takes a fraction of time required to actually “acquire”. There are also so called “Authorizations Only” (authorization hold, card authorization, preauth..) transactions, that create a pending transaction in a cardholder’s account which is settled at a later date.

You might ask — why should I care? This is why — In an authorization only transaction, the selling institution only seeks permission to process a transaction; they do not actually process it. This results in a “pending” charge on the customer’s statement. For those of you who are not privy to the intricacies of payment networks — I’m sure you have seen on your credit card online statements — pending transactions — these are them and they can hold the reserved amount long after it is needed (hotel charges, car rentals, etc.) It can be very annoying for those who have limited credit line.

And what does blockchain or crypto have to do with any of that?! Well, everything and nothing — it depends on your point of view. I would imagine that most have already heard the argument — You would never want to buy a cup of coffee and wait 20 minutes for BTC transaction.

Just to be fair — yes, for smaller transaction (micro transactions) it takes longer to be written into a block. However, whatever time it might take for the transaction to be written, once it is done, it is final — meaning, it cannot be reversed (no chargeback) and the merchant has the funds in the account — “free and clear”. Now, as demonstrated above, credit card transactions do not settle right away. Below disclosure is taken from one of the major payment gateway providers (for obvious reasons I do not disclose the source).

The complete process (settlement) takes a time of T+3* business days, T being the date of capture of payment. * Settlement cycle is subject to bank approval and can vary based on your business vertical, risk factor etc.

One might say — Wait a minute!? I must wait THREE business days to receive my money after I serve a cup of coffee! Indeed, you, just might have to! It also depends on your business vertical, risk factor — let’s assume that most will know what that is :)

Suddenly, waiting 20, 30 or even 60 minutes to receive funds in BTC doesn’t seem like such a losing proposition, does it? Remember, it takes only one BTC transaction to pay/move the funds, and it will take awhile to count all transactions required to facilitate one single payment on VISA/Mastercard network.

Barbarians at the gate and why trust is everything?

If you recall, we are talking about blockchain and cryptocurrency adoption by the banks, more precisely by the banking core systems. So, if you try to argue that current financial system can move money cheaper and faster — you will not win this argument (never mind the BTC price volatility at this time). Previously, we showed the cost of BTC transaction to be much cheaper (it can take only cents to move millions) than existing banking solutions. Even in its infancy as an asset class, cryptocurrency powered by blockchain as technology is more efficient. The matter is the trust factor. Majority today, not without merit, simply trust an obsolete financial system more. We trust it to deliver us our money. This is the pillar, the essence of our wellbeing, that despite frequent crashes, crises and lack of common sense, the current banking system will continue to provide us access to our hard-earned money. Here is the paradox of the current adoption process for this new disruptive innovation — we want the adoption process to succeed while knowing that its aim is to disrupt and destroy the fiat world. The Barbell investment strategy is a method that attempts to secure the best of both worlds. It’s possible, the thinking goes, to garner substantial payouts without taking on undue risk. Is it really attainable with this adoption process? It seems that blockchain and the crypto are like a deadly virus which banking system needs to inject itself with and hope to develop antibodies in time to survive.

To use or not to use will be the question each and every one of us (in banking sector and others) will have to answer for ourselves. The consensus in due time will determine the fate of this new technology.

Trust takes time to develop. A trust that implies our money is even more so. Hard to accept, but I still remember similar arguments being expressed by consumers regarding using “plastic” cards. It was the same resistance to innovation expressed by statements: “Cash is cash, and it will never be replaced by plastic.” Disruptive innovation is a term coined in 1997 by Clayton M. Christensen of Harvard Business School in his first book “The Innovator’s Dilemma.” It describes a process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors (Yes, I have read challenging this view opinions — they do not apply here). This might surprise some; The Diners Club Card, which debuted in 1950, was inspired a year earlier by an “a-ha” moment when a customer named Frank McNamara forgot his wallet while attending a business dinner at New York’s Major’s Cabin Grill. Months later, McNamara and his partner, Ralph Schneider, returned to the restaurant with a small cardboard card and a proposal that resulted in the Diners Club Card.

Are we still waiting for our “a-ha” moment regarding blockchain and BTC? Here is some more information. Due to the public nature of the BTC transaction ledger, we can see what happens as it happens. It shows that there is already enough trust to facilitate some transactions.

All-in-all that’s a market value of over $1.02bn was transferred from dormant wallets in few hours on that day. To put that in some kind of context, that’s a volume of crypto that well exceeds half of the total amount of BTC traded across exchanges in the previous 24hrs. Numbers are just numbers, but transparency of asset flows cannot be even remotely matched by existing banking system. The value of this transparency will also be judged by us, the consumers and bankers of the future.

Another important factor to keep in mind is BTC was never designed for retail operations especially for day-to-day purchases. Technology for its application on vast retail scale has not been developed yet. We need to consider the following:

  • BTC was designed to store and transfer value from point A to point B. A better comparison would be to SWIFT system. I hope we all agree that we would not seek an option to pay for our coffee at the local shop with a SWIFT transfer?
  • BTC is often labeled as “digital gold”. This is not a fair comparison (a subject for a different discussion). However, if you do insist on this, then you can fly to Abu Dhabi and use ATM to purchase a one-ounce gold bar. Then you can go to a nearest coffee shop and attempt to pay for your coffee with your gold bar— good luck. You can also use a different ATM to purchase BTC. You can go to a coffee shop in Prague and use your mobile app to pay for your coffee in BTC — true BTC transaction. You will not have to wait 20, 30 or even 60 minutes for transaction to be confirmed — they will trust you.
  • A few months ago, I sent a SWIFT wire from a US full service bank to European bank, the money was credited to the account and free to be used in just a couple of hours. In most cases, this is good enough, excluding 45.00 USD cost. However, try sending a wire on the weekend. No go — “bankers’ hours”

Hopefully, it became a bit easier to understand advantages presented by blockchain disruptive innovation and the disconnect with expectation from such disruptive technology in such short time.

I believe that adoption of blockchain and its integration into existing core banking systems will be the Rubicon which fiat world is about to cross. Will the fiat world be able to assimilate blockchain and survive? Will the banks be assimilated by the blockchain and become relics of the past like telegraph offices? The time will tell, yet, the fact remains that assimilation of technology doesn’t mean its extinction. Thus, if the banks succeed in lowering transaction costs and increasing transaction throughput by utilizing the blockchain, the question will still remain — why use them at all, if assets can be transferred without them using the same technology.

On a personal note:

I would argue that Blockchain technology is not failing us, we are failing blockchain and BTC with our expectations to become our savior and provide us with insurmountable amounts of personal wealth. To blame BTC for hyperbolic rise to 20K last year, just to re-tract all gains a year later and call it a bubble, is not much different from blaming a gun for the murder and not the person who used it. Most of the people who participated in BTC “investment” late last year could not tell a difference between BTC and CDC. They were driven by FMO and pure greed. Now, they all scream “foul” and call BTC a Ponzi scheme together with Garry Shilling and Ehud Barak, a former Israeli Prime Minister.

Can fraud be perpetrated using blockchain or BTC? Of course; just invest in ICO that promises to tokenize your pet or your neighbor. Can you lose money investing in BTC and crypto? Most likely. You could have followed someone’s advice early this year (or even now) that BTC is going to be worth 1 million, then take a second or third mortgage on your house and invested it into BTC. You can also start day-trading crypto following prediction of some “self-proclaimed crypto Oracle”.

Is blockchain or BTC responsible for the outcome of your actions? Whose burden is it to tell people that Ichimoku clouds, MACD, RSI etc. cannot sustainably indicate crypto price movements, because trading platform for crypto has not been developed yet. Whose burden is it to safeguard people from their own insatiable greed?

Trading crypto futures or options as investment strategy is borderline insane. Born to disrupt and eliminate fiat, crypto has nothing to do with speculative markets and their technical analysis. The only speculative part in this equation should be our consent of how useful crypto has become in facilitating fulfillment of smart contracts as it continues to mature and becomes dominant financial instrument.


This article, was originally published at Altcoin Magazine

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