A mysterious dissertation was published in the years following the financial crisis. It described a new cryptocurrency that existed only on the internet. The currency—now known as bitcoin—would exist in a new electronic monetary system, a so-called blockchain. Bitcoin and blockchain technology would simply replace our existing monetary system, eliminating the need for banks to act as intermediaries in financial transactions.
Although the price for a bitcoin has increased from ten to over 4,000 dollars in the past four years, many people still have a hard time accepting the currency as real money. However, looking closer at the development the blockchain technology behind the bitcoin is undergoing, we might feel differently.
One of the people driving this development is Danish Michael Grønager who holds a PhD in quantum mechanics from DTU. Together with two friends, he has founded the company Chainalysis, which specializes in tracing bitcoins that have been used in connection with criminal activities. To date, Chainalysis has scanned bitcoin transactions totalling more than 15 billion dollars for businesses, including the British bank Barclays, the FBI, EuroPol, and most recently Nets.
“Our goal is to integrate bitcoins into the existing monetary system to ensure that they comply with all regulations,” says Michael Grønager, Chainalysis CEO.
Bitcoins have long been impossible to trace. It has therefore been illegal for banks to offer this type of investment to their customers. National authorities require that financial institutions document where money comes from, and where it is going—also known as the Act on Prevention of Money Laundering.
“The banks were concerned that there were no data relating to the buyer and seller. They wanted to help their customers perform Bitcoin transactions, but they weren’t prepared to go to jail if the investments were found to be illegal,” says Michael Grønager.
Buyer and seller data were available at that time, as every bitcoin transaction is automatically registered in a public database which is freely accessible to everyone. The problem was that no one could read what was in the database. So if financial institutions offered bitcoin investments to their customers, they might actually be helping criminals to launder money because they could not see where the money was coming from.
However, this situation has now changed. Using the software developed by Chainalysis, bitcoins and dealers can be traced through unique series and reference numbers, making it possible to trace all transactions in which both have been involved. Thus, it becomes possible to see whether the bitcoins have been reported stolen or whether the distributor has previously bought or sold anything on illicit online markets. How? It is all to do with how the so-called blockchain technology works—something we will get back to.
Security opens up the market
All bitcoins are actually just numeric values with a serial number hidden in blocks in a chain on the internet—hence the name blockchain. This chain is not protected by a single server in the same way as a normal website. An identical copy, however, is stored in thousands of computers around the world—all of which automatically approve additions to the chain. It is therefore impossible to hack the bitcoin network from a single point—nor can you modify data that have already been added.
When you buy or sell a bitcoin, an algorithm registers data about the trade in a new block, adding it to the top of the chain of existing data. So you are always building on top and are able to go back and see who transferred money to whom.
“What is interesting about blockchain is that for the first time we have a financial measurement of how secure the technology is. If there was an error in the blockchain, you would be able to hack it and steal bitcoins worth more than 70 billion dollars,” says Chainalysis CEO, Michael Grønager.
Even though bitcoins consist of blockchains, the potential of the blockchain technology far exceeds bitcoins. It is a means for transferring data in such a way that it cannot be manipulated. A technology which Nordic Nets—a builder of digital payment systems—has also woken up to:
“We’ve worked with blockchain for some years—mainly due to the fundamental opportunities afforded by the technology, which can provide simpler, yet more intelligent processes with a high degree of transparency. With the blockchain technology, we can potentially build everything from payment solutions to ID and filing systems and a great deal more—and at the same time ensure we have a safe and effective product,” says Simon Buchwaldt-Nissen, Director, Corporate Strategy.
The housing market is an example of another possible application of the blockchain technology. X wants to sell his house and puts it up for sale on the blockchain. Y sees the sales ad and makes an offer to X to buy the house on the blockchain. X accepts Y’s offer, and they both provide a virtual signature—e.g. using NemID—and the algorithm then automatically carries out the transaction. All the transaction data will be saved in blocks and added to a chain of data about house purchases that will remain there forever. And when Y comes to sell the house again, the process is simply repeated.
New electronic monetary system
Since January 2017, the value of all bitcoins worldwide has increased from USD 10 billion to USD 70 billion—in other words, the total current value of all bitcoins is equal to one third of Denmark’s GDP in 2016. So even though bitcoins now live up to regulatory requirements for documentation and can therefore be sold on an equal footing with money, there is still a long way to go before the digital value in terms of volume can compete with national currencies. Michael Grønager from Chainalysis offers his vision of what the market needs:
“If the bitcoin ecosystem and other cryptocurrencies are to grow, far greater money volumes need to be involved. However, before we see equity funds willing to invest or before the injection of pension funds, the system must be completely transparent,” he says.
From a competitive standpoint, whether bitcoins will be ranked pari passu with national currencies in the coming years will depend on supply and demand. The same can be said about the underlying blockchain technology, which according to the IT sector has the potential to revolutionize the way we build computer programs for the transmission of data and assets.
The technology has never been hacked and—according to Professor Jan Damsgaard who conducts research into digital payments at Copenhagen Business School—it removes the need for banks and other intermediaries in transactions—which was the purpose for which the technology was originally designed.
“Looking to the future, intermediaries will not be able to make money from blockchain. They will have to reinvent themselves through a process of digital transformation. It won’t be easy—just look at the problems the postal service is currently experiencing,” he says.
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