Blockchain technology appears to be the new Holy Grail in several industries (eg, banking). Being peer-to-peer (P2P) technology, one of its alleged main advantages is that it cuts out the intermediaries (eg, banks). In my view, that is an oversimplification of the intermediary’s role. Banks are not only intermediaries in nominal volume but also in (foreign) currency, duration, interest rates, and risk appetite. It’s hard to see anything beyond simple P2P matches in Blockchain.
During my 30+ years in Audit and Finance, I have noticed that issues like efficiency, effectivity, user friendliness, and processing speed often conflict with internal control and/or risk management requirements. A Dutch billionaire once told me his view on the contamination risk following interconnectedness. His arguments were convincing and I took his lesson to heart. Enterprise Risk Management may not like a silo approach but businesses may survive using it.
Intermediaries are like hubs in a network. In my 15 January 2015 blog, called “Internet – dependency, fragility and protection” I stated: “In most networks (e.g., airlines, internet) there are hubs (transfer points) as full interconnectedness would not be cost efficient. While hubs create efficiency, they also create risks and threats.” I should have added that hubs can also mitigate contamination risk unlike in full interconnectedness.
In my 17 June 2016 blog on the U.S. nuclear codes, I stated that: “The beauty of this technology is that it is entirely offline. Nowadays, anything online is highly susceptible of breaches by domestic or foreign hackers.” Several weeks later I read that this is exactly the reason why these ancient US defense systems have not been upgraded to modern technology.
In 2003, Warren Buffett compared Credit Default Swaps to financial weapons of mass destruction. He reiterated his concerns about the contracts during Berkshire Hathaway’s 2016 AGM, calling the group of complex derivatives a “potential time bomb” on the balance sheets of banks that is vulnerable to economic shocks. According to Fortune Magazine, he finally took his own advice in 2016 and dumped most of them (ie, offline).
Essentially, risk management is about 2 main event parameters: Probability and Impact. Nassim Nicholas Taleb introduced the term black swan events in his 2007 book The Black Swan: The Impact of the Highly Improbable. Wiki: “The book focuses on the extreme impact of certain kinds of rare and unpredictable events (outliers) and humans’ tendency to find simplistic explanations for these events retrospectively.” Note: all italic markings by me.
Guardian, 2014: “The alternative [Bitcoin] currency has been plagued by hacks, ponzi schemes and increasingly professional thefts since 2011.” This history does not help in assessing the risk of the underlying Blockchain technology.
I am concerned that Blockchain technology might be another “financial weapon of mass destruction” and potentially creating “black swan” events. In my 8 February 2015 blog, I concluded that “In situations that could and – thus – would involve a catastrophic risk [], the Impact should be leading in discussions and decisions rather than its “statistically insignificant” Probability.”
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