Far from being an enabler of crime and fraud, the technology behind Bitcoin actually offers the prospect of greater payment security at lower cost than is possible today. Applications employing some of the same ideas as found in Bitcoin could dramatically reverse the rise in banks' compliance costs in dealing with fraud.
By providing a freely accessible, real-time record of transactions that can be examined using ‘big-data' forensic techniques, the same technology has possibilities to do enormous good in payment systems, securities markets, and even in healthcare.
Bitcoin is a fascinating, emotive, and often polarizing topic. People are broadly divided into two camps. One marvels at Bitcoin's volatile rise in value and speculates that Bitcoin will be the currency of the future, challenging and replacing national currencies. The other camp sees Bitcoin as a haven for criminals and money-launderers, something as unreliable as it is grubby, its steep climb in value as nothing more than a technological Ponzi scheme.
The future of Bitcoin will very likely be as a visionary piece of technology and a significant step in the evolution of currencies. Anyone who claims that the present-day Bitcoin is the finished article is being far too optimistic. Looking beyond the obvious drawbacks of price volatility and associations with badly run businesses like Mt.Gox (a large Bitcoin exchange that failed), there are significant issues with its design that will probably prevent widespread adoption in its present form. To name just three: it looks unsuitable for offering instantaneous small-value transactions, it has an expensive and limiting method for issuing new currency, and creating functioning credit markets in a strictly limited currency would seem to be impossible. However, the technological ideas that underpin Bitcoin are indeed revolutionary and sound. Crucially, those ideas can adapt and evolve. In the same way that the light-bulbs of todayare unrecognizable from Edison's first light-bulb but inherit some of the same basic technology, the basic technology underpinning Bitcoin is proving durable and will feature in applications of the distant future, both financial and non-financial.
At the heart of the Bitcoin system is a protocol that manages transactions. In particular, it uses a dataset known as the block chain, which stores each and every transaction made on the network. It is a distributed dataset, meaning that very many copies are held and maintained by the many Bitcoin users. Transactions are broadcast and ‘seen' by all nodes on the network, and all nodes collaborate to verify the correct state of the block chain. The collaborative nature of this network (known as peer-to-peer) frees it from the need to run under a central authority and, as a side-effect, makes it particularly cheap to run. Participants in transactions are known only by numbered addresses and thus may or may not be identifiable as legal persons, depending on what other records exist linking the addresses to real people. It is an incredibly robust, open and transparent way of recording transactions, in some ways the opposite of Bitcoin's reputation for being anonymous and untraceable.
A fairly straightforward adaptation of the block chain is as the register of shareholders for a company's equity. We dispense with Bitcoin's strict rules on issuing new coin and allow a single authority to issue special ‘coins' (shares) at will. This authority also maintains records linking network addresses to known legal persons (shareholders). The identity of shareholders may be disclosed or withheld, as appropriate. The block chain is a suitable, low-cost way of disclosing the ownership of the company to public and regulators in real-time.
Could this way of recording transactions be harnessed to reduce fraud? Early systems for preventing fraudulent use of credit cards were rule-based and clumsy. They worked by defining narrow criteria for what constituted a ‘normal transaction' for a cardholder and attempted transactions not within those criteria, would be queried or perhaps declined at the point of sale. Over time, credit card companies discovered that a better way was to use data mining techniques on the transaction records to detect breaks with normal behaviour. The utility of these ‘big-data' techniques multiplies when the dataset gets bigger, for instance, when several credit card issuers agree to pool databases. Insurance companies found that by agreeing to share claims data with each other, they achieved a steep reduction in fraudulent claims far beyond what a single company could hope to achieve. Now if credit card companies used a shared block chain with identities concealed behind suitable addresses, the entire live system of transactions could be opened up to scrutiny. In theory, this dataset would enable the most powerful tools for detecting fraud across the whole system whilst also transforming fraud detection into a shared cost amongst providers.
So, what else could the block chain be used for? It turns out that we can record all sorts of information in the form of transactions. Even one's medical history - the diseases suffered and the drugs prescribed - can be represented as a list of transactions with special content. With suitable anonymous addresses, a block chain could provide a globally available and real-time repository of medical histories, independent of individual health authorities or governments. If this is additionally linked to a digital representation of individuals' genomes, the resulting dataset becomes an enormously powerful tool for medical researchers. It could dramatically shorten drug development and testing cycles. It would take a lot of the guesswork out of making the right prescription, and with disease outbreaks being monitored accurately as they happen, it would be an important tool for early diagnosis too.
Bitcoin is the flagship for a wide range of technology development projects known as crypto-currencies. Partly owing to the success of Bitcoin, both as a technology experiment and as a publicity magnet, crypto-currencies are garnering significant interest from governments, banks and notably from venture capitalists, eager to fund technologies that may play the same role for money as the internet plays for information. The internet made the cost of publishing and consuming information very small, and crypto-currencies promise to do the same for paying and receiving money. As was true of the internet, there may be crypto-currency applications we can barely imagine right now that will prove to be the most valuable of all.
By Professor Jonathan Rushman of Warwick Business School
