UBS, the Swiss bank, pioneered the “utility settlement coin” and has now joined forces with Deutsche Bank, Santander and BNY Mellon — as well as the broker ICAP — to pitch the idea to central banks, aiming for its first commercial launch by early 2018.
Bitcoin and related crypto-currencies primarily promise to cater to the so-called “un-banked,” so why would a major bank attempt to leverage blockchain technologies?
Simply put – it saves tons in administrative fees. Those who are regular users of Bitcoin (particularly for large-scale and/or international transactions) may not realize how much of a value they’re attaining at the expense of the banks. According to the report by Santander Innoventures that heralded today’s announcement, blockchain technologies could reduce banks’ infrastructural costs by $15-20bn a year by 2022. Simply put, there are enormous administrative staffing and technology requirements to reconcile international and inter-bank transfers.That’s why there’s been a number of coin, blockchain and crypto startups created to tackle this issue specifically (Setl and Ripple being two prime examples).
So what is Santander and the other banks using for this application?
One might imagine that they would try to use an already in-market solution, or even Bitcoin itself, but instead they’ve deigned to create a custom implementation of Ripple, a digital currency solution that’s been around for quite some time. Details on the banks’ implementation of Ripple are scant at this time, but from what we do know about Ripple, we can make a few sets of assumptions on how their system will work.
Ripple is a fundamentally different system of value exchange than Bitcoin or most other cryptos. Adam Levine of Let’s Talk Bitcoin summarized it neatly back in 2013. Some parts of Ripple have changed since then, but it’s essentially still an apt description of how value exchange compares and contrasts with traditional crypto:
For those of you not familiar with the Ripple system, it can be thought of as a parallel development to Bitcoin that tries to solve many of the same problems; trustless, bankless money transmission to anywhere in the internet connected world. Ripple goes about solving the problems slightly differently.
There are no miners; transaction validity is determined by a cascading consensus engine. Ripples themselves (XRP) were fully pre-mined and initially owned by Ripple Labs. They aren’t really traded as currency themselves, instead they are intended as an anti-spam mechanism – Like a stamp on an envelope with a check inside.
Where Bitcoin is an ownership based person-to-person system, Ripple is built on interconnected networks of p2p credit. Bitcoins are wholly owned with no risk of the redeeming party defaulting.
The Bitcoin system transfers ownership of one thing – Bitcoins. People can build layers on top of it to do other things, but at a protocol level it’s just bitcoins on the Bitcoin network.
What if you don’t want to send Bitcoins? Ripple is a good option. When you send US dollars through the Ripple system, you’re really sending IOUs that will be redeemed somewhere else in the system. Depending on your need to transact in non-Bitcoin terms, this might be important- or you might prefer instead the wholly-owned nature of cryptocurrency.
In some situations, Ripple sounds like it could work – and in the case of banks that don’t want to transfer vast sums of value onto a blockchain, perhaps a Ripple-like IOU approach is the way to go.
In my opinion, though, Ripple has some fundamental flaws that must be examined and weighed both for the benefit of banks looking to move to this new technology as well as folks looking to innovate on blockchain technology in the crypto-sector. A report commissioned by distributed ledger consulting group R3CEV and authored by bitcoin developer Peter Todd has raised questions about Ripple and it’s ability to withstand the rigorous security demands of high-finance.
“Ripple still holds the majority of XRP, and it is in their favor for its value to increase,” says the report. “Ripple justifies XRP as an ‘anti-spam mechanism’ to deter transactions… However, as the volume of transactions increases the server load, transaction speed is slowed while the cost of the transaction and the amount of required XRP continues to increase.”
Todd next walks readers through a number of theoretical attacks that could take place against the Ripple protocol, discussing his estimates of the cost, scope, duration and probability of the scenarios.
Perhaps the most glaring, Todd’s writing infers, is the damage that could be done due to a “software backdoor”, as he finds that Ripple “does not provide a secure way to download any of their software”.
“This is a serious omission that has lead to significant monetary losses in the past. Ripple Labs should be following industry best-practice by signing git commits and tags as well as PGP signing their Ubuntu packages,” Todd added.
Todd ends by highlighting the potential real-world implications of these attacks in an elaborate scenario involving a dispute between the Russian government and Shell Oil, forecasting how these parties might attempt to achieve their aims through coercion on the network.
This is a common flaw in some implementations of cryptos as well – those looking to launch a new cryptocurrency and looking to avoid being 51% attacked during the nascent moments of the life of the coin may look to private mining or some other form of centralization, but in these cases, they’re creating honeypots for hackers as well as the key thing blockchain technology was designed to mitigate: central points of failure. As we discussed in the Bitfinex post a couple weeks ago, the common key component to every major loss, theft or hack in cryptocurrency history has been central points of failure.
My prediction is that this group of banks will move forward with their implementation of Ripple, and see some gains from using this new technology, and likely use it as a stepping stone to more open versions of the technology in the future.
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