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The blockchain paradox - opinion

07 December 2016

Paul Dowding, Gartland and Mellina Group, says that current blockchain designs are not able to provide real-time solutions but a solution is technically possible

In one of his famous paradoxes, the ancient Greek philosopher Zeno tells us how Achilles decides to race a tortoise but allows it a head start. When the race begins, Achilles runs to where the tortoise started but finds it has already moved. He then runs to the point where the tortoise moved to, only to again find it slightly ahead. This cycle continues until Achilles finally gives up exhausted, unable to ever overtake.

Current blockchain solutions in the financial services industry have their own logical paradoxes to overcome. A blockchain ledger needs a validation mechanism, yet this introduces capacity constraints and latency, which, like Achilles, means it can never catch up with real-time processing.

While Bitcoin, the original use of blockchain, dealt with simple transfers of ledger-referenced value, Wall Street’s full set of interdependent products and lifecycles represent an Olympic pantheon of events.

Additionally, current blockchain solutions require an ever-expanding continuous record in order to access any prior transactions and balances, which ultimately generates a storage requirement that is not viable. Not only has the blockchain to catch up; it also faces a continuously moving target. This problem has no – at least publicised – solution and often is described conferences as "being worked on".

Consensus algorithms

In order to increase the speed of processing and validation in the ubiquitous consensus algorithm, the industry is looking at various innovative ideas that include sharded consensus (a divide-and-conquer mechanism to create a quicker, fragmented, trusted-node consensus) and lightning networks (where transactions are agreed outside the main blockchain and then recorded in it later). While there are benefits of these solutions they cannot support the real-time transactions that are critical for market-making or algorithmic trading and execution.

No use cases yet exist for truly complex transactions. While there are current use cases involving repo, syndicated loans, credit default and interest rate swaps that may be complex in terms of structure, valuation and monitoring, they are all over-the-counter (OTC) transactions. Such OTC transactions are based on low-volume, unregistered securities where settlement is predominantly for payment streams. These merely represent customised versions of the simplest use cases.

In addition to the speed, capacity and scalability challenges, there are also complex market interdependencies to consider. Consider a fund manager selling a bond when that bond had already been put out on loan by the custodian, the borrowing broker had passed it on to a hedge fund, the hedge fund sold it short, and the buyer from the hedge fund is a money market fund. There is no easy way to represent that complex interdependent settlement lifecycle in a ledger-referenced system.

Rather than iteratively enhancing initial, basic blockchains, a blockchain solution designer has to address the challenges that are required to support the whole financial services industry. If a blockchain solution cannot address all of these challenges, it will have limited use and benefit to the industry. These include:

·           A flexible means to code and control multiple lifecycles

·           Ledger processing and validation that allows for scalability and real-time capacity

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