Careful who you hang with, 'cause trust is a really big word you know.
-- Ayo Nation
Poor pathetic Ethereum. It's the cryptocurrency that has lost its way. And now it's fallen in with a bad crowd. Here begins a chronicle of Ethereum's decent into cryptocurrency hell, where the bank dealers will use it like a worn-out dishrag.
Once Ethereum was the smarter, younger, brother of the black sheep of the cryptocurrency family: Bitcoin - the largest cryptocurrency by volume. But Ethereum has fallen on hard times. The banks, however, are triumphant. They have done the once unthinkable. They have bloodlessly captured their first public cryptocurrency.
This story provides the skinny behind the little-noticed dalliance between Ethereum and a consortium of banks and like-minded behemoths, which calls itself the Enterprise Ethereum Alliance. Members include Accenture (NYSE:ACN), BBVA (NYSE:BBVA), BNY Mellon (NYSE:BK), BNP Paribas (BNP), BP (NYSE:BP), Cisco (NASDAQ:CSCO), Credit Suisse (NYSE:CS), ING (INGA), Thomson Reuters (NYSE:TRI), UBS (NYSE:UBS), J.P. Morgan Chase (NYSE:JPM), and Banco Santander (NYSE:SAN).
The failed Ethereum plan. The geeks who write Ethereum code sought, in vain, to be ruled by machines. You want that if you are a geek. Having failed to achieve their misbegotten vision of utopia, Ethereum mavens have found the next best thing. They will be ruled instead by the dealer banks.
But the brave new world that once was Ethereum lost its credibility as a cryptocurrency; and finally had no alternative but to become a captive of the dealer banks.
The bankers' fear. The dealer banks view cryptocurrencies as an existential threat, the negative motive for their deepening involvement with the technology. But on the positive side, they - and financial regulators as well - see the possibility that there may be ways the traditional function of banks - providers of trust - can remain, through cooperation in some ways with the Bitcoin technology, which makes trust of financial institutions - a crumbling virtue in recent years - seemingly obsolete. Well OK. Bitcoin will never render the banks, or trust of banks, totally obsolete. But obsolete in the banks' once primary role of asset transfer, at a minimum.
In the beginning, there was Bitcoin. Bitcoin started all the cryptocurrency commotion. Ethereum was originally a reaction by code designers, to a reaction by bankers, to the true innovation - Bitcoin.
Despite a bazillion claims of others to blockchain creativity, Bitcoin is the only genuine transaction paradigm change, to date, in what has become known as "the blockchain space."
To understand the current level of ridiculous hype surrounding putative "disruptive innovations" called blockchain - or alternatively, a distributed ledger - it is useful to know that these two concepts are not particularly new. When you see the latest application of blockchain to some financial inefficiency, breathlessly touted as something that could never, never, have possibly been so radically transformed without a blockchain, it is useful to know that blockchain and distributed ledgers are identical shopworn decades-old technologies, collecting dust on the shelves of mad IT geniuses.
The term "blockchain" was coined by the creators of Bitcoin to describe their own distributed ledger, non-innovative in itself. But the term "blockchain" is a much more descriptive term than the term "distributed ledger," so it's useful even though it's not new technology. just a word.
If technological opportunity was the driver of the blockchain obsession, blockchain would have been integrated into banking long ago. But no. The reason for the fad is banks' desire to protect their turf from invading cryptocurrency disruption.
There will be, without doubt, innovative applications of distributed ledger technology other than Bitcoin, but the publicly announced bank applications of blockchain technology to date are not among them.
But Bitcoin is different. In one fell swoop Bitcoin transformed ordinary distributed ledgers into something more than a database. And Bitcoin's potential was indeed arresting, worthy of sitting up and paying attention. There are two fundamental properties that make Bitcoin conspicuous.
- What makes Bitcoin something other than the same old blockchain is the transformative idea: bitcoin miners. The use of miners to protect Bitcoin is a game-theoretic concept, the Nash Equilibrium. Bitcoin is a means of transferring value without an intermediary such as a bank or an exchange. And God knows, the weary world seeks a way to replace many costly and out-of-date services that banks provide today. It is no secret that the internet transformed traditional banking services from a necessity to an obstacle. This the banks understand all too well. There will always be financial institutions. But much of what they do, from funds transfers to retail lending and deposit-taking, is better computer-driven on the internet than people-driven in branches. This transformation from people to computers is proceeding at a snail's pace as banks cling to their fee income and hidebound ways.
- And even more significantly, Bitcoin will most likely never be hacked. As such, it can remove perhaps the most significant obstacle hindering the advance of internet commerce today, the growing problem of hacking. Indeed, if Bitcoin is ever hacked, the hacker will most likely be a government, since only governments command the enormous resources required to hack Bitcoin. This makes Bitcoin a potential replacement for everything the internet touches, including the internet itself.
Miners and the Nash Equilibrium. Without getting into the mathematical and technological weeds of mining, the miners are intended to do for hacking what Adam Smith did for war. Adam Smith found a less expensive (and less dangerous) way for warriors to obtain valuable things from others, namely competition, production and trade.
Hackers, like warriors, forcibly take valuable information and other people's stuff. Hackers use the internet and computer power, instead of main battle tanks. Bitcoin's creators, by introducing the miners, created a more profitable use of computer power than hacking. In other words, it makes no sense to hack Bitcoin. You can make more money mining Bitcoin, which makes it hack-proof.
Bitcoin rewards the use of computer power to verify the accuracy of transactions. The result: it's more profitable to use computer power to protect Bitcoin than to attack it.
All innovations are ultimately improved. So, there is always purpose in seeking a better way. But make no mistake. The real prize in this game lies in creation of a global-scale transactions system that replaces the banks' firewalls with Bitcoin-like trustless security.
The Banks' reaction to Bitcoin. They recoil in horror. Let there be no doubt. The current bank fascination and enthusiasm for blockchain, blockchain, blockchain, is inspired solely by fear of Bitcoin. It's a diversion.
It is not hard to understand the banks' abject terror. They don't fear being "disrupted" by Bitcoin. They fear being replaced by Bitcoin. This fear is, however, greatly exaggerated. Indeed, the fate of Ethereum, Bitcoin's smarter brother, laid bare, for the world to see, the reasons why "finance by code," the heart of the Bitcoin threat, is a non-starter.
But what is possible, even likely, is that great yummy hunks of bank profitability will be destroyed by Bitcoin, or perhaps, a Bitcoin successor.
This explains the bank's negative motive for involving themselves with blockchain tech. But the hook-up with a public cryptocurrency changes the game. Now the banks are free to grab the big brass ring. They can build a public cryptocurrency, or something very similar, that has the regulatory and legal properties that Bitcoin lacks, if they are willing to replace inefficient legacy systems with some form of miner-based security. Stay tuned.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.