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As Banks Slam Bitcoin, They Invest in Blockchain

· September 19, 2017

At a conference last week J.P. Morgan Chase & Co. chief executive, Jamie Dimon, slammed Bitcoin, after which the cryptocurrency’s prices plunged. Dimon referred to Bitcoin as “a fraud” and asserted it was “worse than tulip bulbs” — basically the worst currency insult you can levy.

Some speculate Dimon’s skepticism is rooted in fear of cryptocurrencies’ potential to disrupt the financial industry, which has attracted harsh criticism for its conduct leading up to the financial crisis.

While Dimon, and others like him, continue to denounce cryptocurrencies, at the same time, J.P. Morgan and other critics are investing in Bitcoin’s underlying technology — blockchain — in an attempt to keep pace with cryptocurrencies’ capabilities.

Blockchain first appeared in October 2008 in Satoshi Nakamoto’s proposal for a virtual currency called Bitcoin. (You can check DisCo’s earlier reporting on Bitcoin here.) According to Nakamoto, the currency would have no central authority to oversee and manipulate its quantity, no intermediaries to verify and secure transfers, and it would be completely virtual.

This would be possible thanks to “blocks” and “chains.”

“Blocks” are simply records of users’ transactions, as you would see in any physical ledger. The “chain” is created when blocks are strung together. To ensure third parties cannot manipulate and tamper with this ledger the chain is secured using cryptography, a method of protecting information by constructing protocols now, increasingly, using mathematics and computer science.

Users create and verify blocks in the chain at timed intervals by “mining”—essentially using their computer’s resources to cryptographically authenticate prior transactions in the ledger. To incentivize mining, users who successfully validate a block of transactions are rewarded with a set number of bitcoins, though this reward is not necessarily reflected in all blockchain implementations.

This technology (eventually referred to as “blockchain” in 2016) was attractive to users, as it enabled them to instantly, and securely, transfer currency without relying on intermediaries, such as banks or brokers, traditionally tasked with verifying and confirming their customers’ transfers.

There was also a certain assurance that funds would remain accurate, and secure, due to the public (yet anonymous) nature of its ledger. Essentially, the distributed and self-verifying nature of the blockchain ledger solves the “double-spending” problem that hindered the development of earlier digital currency systems.

Overall Bitcoin’s value has reflected this sentiment; as of September Bitcoin’s price has almost quadrupled, currently hovering around $3,600, and it has attracted almost 17 million users.

Yet criticism has not relented.

In 2014 Goldman Sachs published a report in which it concluded that “bitcoin likely can’t work as a currency.” Other banks have turned up similar reports, with some calling for Bitcoin and other cryptocurrencies to be regulated like traditional financial institutions. Bank of America also recently released a survey that called Bitcoin the “most crowded trade.”

In response to Bitcoin’s rise, financial institutions — along with levying criticism and even attempting to file patents for its technology (and failing) — appear to be banding together.

In September 2015 nine top banks, including Goldman Sachs and J.P. Morgan, announced a partnership, spearheaded by the “enterprise software firm” R3, to develop a shared ledger for global financial markets.

In joining the members agreed to: “collaborate on research, experimentation, design, and engineering to help advance state-of-the-art enterprise-scale shared ledger solutions to meet banking requirements for security, reliability, performance, scalability, and audit.”

Many of these same members also joined the Enterprise Ethereum Alliance (EEA), “an open-source, public, blockchain that anyone can use as a decentralized ledger… [with] its own cryptocurrency called ether.”

Ethereum, though similar to Bitcoin, differs in that is exists primarily in the corporate world, whereas Bitcoin is consumer-facing. More importantly, while Ethereum does have cryptocurrency, its primary use is as “a platform for new kinds of decentralized (often financial) applications (dApps) that run on a peer-to-peer network of computers.”

Imagine taking Bitcoin’s capability — allowing consumers to safely and swiftly transfer currency or record transactions on a public ledger — and permitting others to insert it into their own applications. This is what Ethereum does; it gives companies and entrepreneurs the ability to use their software — Ethereum’s public blockchain — to create their own applications. And, in exchange for using these applications, users pay a small fee in Ethereum’s cryptocurrency, ether.

Its adoption by so many corporate sponsors — the EEA’s total membership topped 150 in July of this year— has lead many to assert that Ethereum could “eventually be bigger than its early stage rival,” Bitcoin.

The size of the consortium may, indeed, provide it with a competitive advantage. Many different applications can exist on the platform and, most importantly, are interoperable because they use the same blockchain/cryptocurrency. This may give it a greater chance of having more real-world applications— a common concern for Bitcoin.

Partnerships like the R3 consortium, however, seem to be quickly disintegrating as members exit to pursue their own blockchain projects.

Goldman Sachs and Morgan Stanley recently left the R3 consortium to “pursue their own blockchain projects and alternative collaborations.”

It’s unclear how this move will affect the consortium’s competitive advantage and, for that matter, Bitcoin.

If these singular projects are effective, other companies may, in turn, create their own blockchains, further decentralizing former partnerships and inserting more competition into the already competitive cryptocurrency market.

According to recent stats there are currently over 700 cryptocurrencies. And, though Bitcoin currently comes out on top in terms of price and average users, Ethereum and Ripple, another global payment system, could challenge this position — particularly on account of their appeal among banks and other businesses.

Bitcoin, meanwhile, could adapt in response to these emerging competitors, allowing businesses and entrepreneurs to utilize the blockchain’s other transactional and record-keeping advantages, as Ethereum does.

Bitcoin’s quick recovery, however, suggests it may be more resilient; despite decreasing over 30% in value this past week, due presumably in part to Dimon’s comments, its value recovered quickly and now hovers just below its price before the dip.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.