I recently had dinner with someone who holds sizable cryptocurrency positions. He reiterated what I hear often from people bullish on public blockchains: private projects like R3 are great insofar as they will win the banks over to using a cryptocurrency as their form of value transfer.
Though I’m sympathetic to cryptocurrencies as a social and economic experiment, I believe this transition will never happen. Most cryptocurrencies are optimized to achieve a high-integrity ledger while evading censorship. The design choices that allow for cryptocurrencies to thrive in hostile environments also pose a tax on the throughput and efficiency of these systems.
Many of the design choices that render cryptocurrencies unsuitable for financial services can be altered through forks, whereby the cryptocurrency’s protocol uses new conditions for validating transactions in the network. While these events can make cryptocurrencies more attractive to financial institutions* (likely while alienating their existing user base), the methods available to implement forks point to a larger issue with cryptocurrencies: a lack of robust governance structure.
Two Case Studies
The world has already seen two major crises arise from a lack of governance mechanisms in the two most popular cyptocurrencies: Bitcoin and Ethereum.
Over the last eighteen months, the Bitcoin community has undergone a debate over how the Bitcoin protocol should scale to support more transactions. Without getting into the technical details, several proposals were made to achieve this – some of which were mutually exclusive to one another. Ultimately, the debate over how to amend the protocol led to intense disagreement among the Bitcoin developer community. The path forward had no means to transfer from debate to enforcement in a dynamic fashion.
More recently, some aspiring former Ethereum developers created a smart contract-based, kickstarter-esque, investment project called “The DAO.” Unlike traditional investment management shops, The DAO was to be governed exclusively by a few thousand lines of code and the votes of its token holders to pick investments. Though it was known to have several critical deficiencies prior to launch, the brazen developers behind the project pushed it to market. When one of the many issues with The DAO was exploited to the tune of ~$50 million going to one clever hacker, Ethereum holders were incensed and called for some form of time-out.
In the heat of The DAO exploit, a hard fork to “undo” the DAO was proposed. At first, the Ethereum Foundation said that they miners would decide if a soft fork to freeze the hacker’s account would take place. Then, the Ethereum Foundation incented miners to soft fork. Soon after, a proper hard fork emerged. For concise summaries, see my colleague Tim Swanson's posts on the topic - and related ppt for consultants. Long (and unfinished) story short: though the Ethereum Foundation, miners, etc. pursued a course of action, it remains unclear what threshold of dispute over ETH/ETC at the hands of buggy code will cause them to hit "reset" again.
In short, cryptocurrencies allow stakeholders to benefit from the integrity borne of the incentives for miners… until they don’t. This is a poor value proposition for banks, which are already subject to the will of many external parties. In order to survive, cryptocurrencies will have to learn how to incorporate governance.
* - Though probably not ever because the world still does their accounting in terms of dollars, pounds and the like.