Fiat Currencies Are About to Become Essential to Public Blockchains

We were promised a global financial and industrial revolution. We got a mango tracker.

Three years since enterprises started exploring the possibilities in blockchain, it’s perfectly understandable to be disappointed with what we’ve got so far.

But believe it or not, the seemingly banal applications for blockchain we’re seeing, from food traceability to software licenses, are a big deal and rightly worth celebrating.

The biggest journeys take place one step at a time, and when it comes to enterprises, it’s a particularly long journey. That 22,000-word software license agreement you clicked “yes” to without reading? Enterprises are reading every word of those things and arguing over the details. Adoption of technology inside the enterprise is sticky and durable, but it is also very slow as these systems are fragile and have many decision makers.

If you want to beg forgiveness rather than ask for permission a la Uber, that’s your call. If you want to put a Fortune 500 company’s cars into an asset-sharing system, be prepared to spend the next year locked up with the legal team.

As important as the milestones achieved so far have been, there’s a much longer way to go and in this series of articles, I will examine the key transformations that need to take place for blockchains to go from interesting prototypes to production systems solving niche problems to general-purpose tools for moving value of all kinds around.

We’re just transitioning from the interesting prototype into the niche problem-solving category, with things like food and wine traceability and software licenses leading the way as good case examples.

Going public…

Right now, nearly all enterprise blockchain examples are confined to private networks and, typically, non-financial systems. To get from niche use cases to general-purpose transactions suitable for all businesses, four transitions must happen.

The first is a shift from private, permissioned blockchains to their chaotic, public and permissionless counterparts. Like the move from private company systems to the internet, it looks scary now, but in a few years, we will all look back upon it as inevitable.

There’s a good reason, however, that nearly all enterprise solutions today run on private networks: privacy. Public, permissionless blockchains, though they are based on key principles of cryptography, actually run most data in the “clear” – which is to say unencrypted. If you want to buy raw materials from suppliers and partners and you do so over the public networks like ethereum today, your pricing deals and volumes and partners will all be easily visible to your competition. Not very attractive.

And so companies have opted for private networks. But private networks, even industry consortia, don’t scale very well. If you form a private network for food traceability and you want to ship the food and insure that shipment, you’ll end up needing half a dozen different blockchain connections to complete the whole transaction.

Some companies are working hard on connecting up lots of different private blockchains. That’s going to be expensive and our fear is that hackers will have a field day with those interoperable systems. This isn’t a strategy that has worked in other industries and eras, and we don’t see it having a better fate this time around either.

If you’ve been around long enough, you remember when companies had point-to-point connections for their email systems. It worked, just barely, but only for a few companies to talk to each other.

…while keeping data private

The internet and public key encryption made it possible for us to email everyone, everywhere securely without any predefined interconnections. With zero knowledge proofs, we believe the same will be possible for blockchain transactions.

This technology, which has been proven in a number of prototypes, is now being industrialized. It will allow all companies to work on public blockchains and to enter into contracts with each other securely and privately.

The mathematical principles that underpin zero-knowledge proofs are very complex, but the effect is very simple. I can prove to you something is true (e.g. I have a certain number of mangos, or I have delivered them to a certain customer or location) without enabling anyone else to understand the underlying data.

This means you can preserve the immutability and redundancy of a blockchain by allowing anyone to verify the truth of information and approve a transaction – something that is critical to consensus algorithms in decentralized systems – without exposing the details for all to see.

The same scenario we discussed before (buying product, shipping it, insuring it and tracking it and paying for it) can not only be done with a single contract with multiple parties, it can all take place on the same blockchain and be executed securely, privately and reliably.

Getting on to a shared, public infrastructure is critical for blockchains to scale globally and to move from very specific industry solutions into general purpose tools for moving value and enabling business agreements.

Though we think it will take some time to fully industrialize the implementation of zero-knowledge proofs, the payoff will enormous.

In my next article, I will take a look at the second key revolution we expect in blockchain technology: the transition from notarization to tokenization.

Cryptocurrenices ask you to put your trust in math and not in fallible central bankers, but they come with a lot of political baggage of their own.

In particular, cryptocurrency boosters talk a lot about how central bankers have debased currencies over the years and how the printing of money by central banks has done much to impoverish people around the world. In an imagined future world of cryptocurrencies, fallible and politically influenced central bankers are replaced with algorithms and currencies get more valuable over time, not less so.

There are a lot of problems with this narrative, starting with the fact that a little bit of inflation is actually useful and the painful era of stagflation is more than 30 years in the rear-view mirror. Independent central banks are among the most trusted institutions in our economies, and also the most transparent. And while the market capitalization of cryptocurrencies seems large by absolute standards, it’s tiny compared to the rest of the global economy. Daily trading of cryptocurrencies is between $5 billion and $6 billion right now. Daily trading on the foreign exchange markets is closer to $5 trillion.

Even if cryptocurrencies continue to grow (and they most likely will), if we want blockchains to deliver upon their promise, we must be able to transact using traditional fiat currencies. There are lots of practical reasons for this, the most important of which is the management of risk for enterprises.

Nearly all business transactions today are done in traditional fiat currencies. Traditional enterprises generate most of their revenue in those currencies and they also handle all their debts and payments in the same currencies.

In order for firms to transact on the blockchain, they will want to transact in those same currencies. If I have a deal to buy a product at a set price in euros, and I execute that contract on a public blockchain, then I also want to settle it in euros, most likely. Every time I move money between currencies or hold substantial amounts of a different currency, I’m adding foreign exchange risk to my business, which serves no purpose if it can be avoided.

One option for companies engaging in smart contracts on blockchains is to arrange payment settlement through the banking system separately and simply record that payment on the blockchain. This option works, but we believe it is a less-than-ideal solution when you start to consider the broader economic ecosystem that you are enabling on a blockchain.

All in one

The best option for companies entering into business contracts on a blockchain is to complete the full exchange of asset tokens within the same blockchain. Asset tokens (representing product) are exchanged for money tokens in the simplest format, but with all the tokens being represented in the same blockchain, more sophisticated options are possible. Companies can borrow against inventory, with loans repaid automatically upon the sale of the inventory, for example.

At EY, we’ve taken to calling this a “full cycle economic contract” as the gold standard for what enterprises will want to achieve using blockchains for commerce. Full-cycle digital contracts will not only be lower risk, since both assets and liabilities will be transparently managed on the blockchain, but almost any kind of financial service can be delivered against those flows with minimal cost for the transactions.

Ultimately, this means billions of dollars in tokenized fiat currencies must be available on the public blockchains to facilitate these transactions and payments. If this path does come to pass, however, it means that central banks will have to find a regulatory structure or approach that allows for multiple currencies and tokens to co-exist on public blockchains – networks they do not regulate or fully control. It also means that private central-banking blockchains are not necessarily likely to have a big role ahead.

We believe, however, that there are mechanisms for regulators to control their own currencies in decentralized public networks, and I will dive into that and more in my next post.