The Impact of Second-generation Cryptocurrencies on Banking

By Giuseppe Gori, CEO, Gorbyte, Inc.

Since the advent of Bitcoin, over ten years ago, the cryptocurrency market has been very active, but mostly speculative. Many new currencies have been created, but not much has changed in their basic conception. Some cryptocurrencies are pinned to the US dollar to achieve stability, but may be susceptible to other problems.

Bitcoin vs. USD Volatility (From: BuyBitcoinWorldwide)

We should not be surprised that, after 10 years of Bitcoin, most current fintech articles on cryptocurrencies consider blockchain technology as a fait accompli. The common assumption is that not much will change in the Distributed Ledger Technology (DLT), and the cryptocurrency world, in the next few years.

However, really disruptive changes are sudden. With the rate of acceleration of today’s technology, change is unpredictable and its impact is sometimes beyond expectations.

First-generation crypto-networks, such as Bitcoin and Ethereum use leader-based consensus mechanisms. These networks are decentralized: A “proved” subset of their nodes, miners or verifiers, compete for a reward and the winner is temporarily in charge of transaction verification, block composition, and distribution of the current block to all other nodes. These networks, after ten years of attempts, have not been able to scale. Their currencies are volatile and are used for speculation more than as a medium of exchange.

Distributed applications are still waiting for faster, scalable networks.

Governments are not happy about the trends towards anonymity of their users.

The ability of users to securely handle their keys and write secure applications is questionable.

Second-generation, stochastic crypto-networks will cause a sudden change in public blockchain technology by moving from decentralization to distribution: What
DLT technology was supposed to be, but never was.

Random sessions in stochastic cryptonetworks (© G.Gori)         

In stochastic crypto-networks, every node has equal responsibility for the verification of transactions, network security, and block equalization. 

These networks will not need intermediaries and rewards. Their basic transaction services will be free. More importantly, they will be faster, scalable, secure, and able to support applications that require the exchange of large amounts of data.

Stochastic crypto-networks are described in my soon to be published book “Reinventing the Blockchain”, with a foreword by George Gilder. Stochastic crypto-networks, and their corresponding cryptocurrencies, will have a marked impact on the banking and financial industry.

Stochastic crypto-networks will disrupt financial services and provide the opportunity for new services, creating non-volatile cryptocurrencies and bypassing bank payment systems. Stochastic crypto-networks will also disrupt distributed application development by providing a simpler model for general blockchain applications.

Current operating systems will morph into Distributed Operating Environments, including personal wearable devices, corporate servers, autonomous robots, and IoT devices, all cooperating to maintain current replicated data securely and immediately available on any of these systems.

Second-generation cryptocurrencies will be non-volatile. Simple movements of money will be free, just as we enjoy many other free services when subscribing to a plan for accessing the Internet. They will be an effective means of exchange with the potential of replacing fiat currency: People will be able to move money to each other easily and transparently without fees, just like moving cash, but with the added advantage of traceability, which is an insurance against theft and money laundering. Payment systems will be disrupted.

Second-generation cryptocurrencies will also be an effective store of value, because

a) they will have no inherent inflation;

b) prices, expressed in these currencies, will not be volatile; and

c) people will receive directly into their wallets their share of proceeds from all earnings by the crypto-network.

For the above reasons everyone, including the world’s unbanked, will enjoy the use of a no-fee, interest bearing savings account (or wallet) maintained by their own tamper-proof personal device: A blockchain-registered device acting as a node of the crypto-network.

Such accounts will be recorded on the blockchain on every network device. Each device will be biometrically paired to its user. Users will not need to trust a bank, an exchange or an intermediary for holding their accounts.

In periods of economic growth and currency demand, new currency will be generated immediately by the crypto-network. To prevent this new currency infusion from causing artificial inflation, increments compensating for the reduced value of the currency will be immediately accounted in each user wallet. These will exactly compensate currency owners for the increased currency in circulation.

All users will experience growth in the nominal value of their wallet, but no change in prices. In other words, everyone’s standard of living will improve at the rate of economic growth, and in proportion to their savings, without government or human interference.

Because of the ability to react to changes in currency demand in a precise and timely fashion, when second-generation cryptocurrencies will be widely used, the cycles of worldwide economic contraction and expansion will also be a thing of the past.

Furthermore, second-generation cryptocurrencies will not be deflationary.

While today cryptocurrencies are mostly a speculative instrument, this will end with second-generation cryptocurrencies, as they automatically will respond to changes in demand to maintain price stability. In addition, their short-term variations will be mathematically smoothed to avoid short term speculation by automatic means.

Daily Volatility (Forbes: Bitcoin volatility by the hour)

New generation cryptocurrencies based on stochastic crypto-networks will positively disrupt the cryptocurrency market and cause a consolidation of the many types of cryptocurrencies in circulation today. For example, most current cryptocurrencies using leader-based consensus mechanisms (Proof-of-Work, Proof-of-Stake, Proof-of-Capacity or proof of anything else), may remain only as speculative instruments. These first-generation crypto-networks do not respond to the expectations of cryptocurrency users, as users still need to trust verifiers/producers for the maintenance of the crypto-network.

With stochastic crypto-networks, key management will be automatic and transparent, providing users with preemptive and theoretically absolute security. At the same time convenience will improve, as users will not need to remember keys, IDs, passwords, or other codes.

Authentication mechanisms will be transparent and will apply automatically, as the user approaches or needs access to restricted areas and private resources (buildings, vehicles, shops, events, accounts, etc.).

Cumbersome mechanisms, such as two-factor authentication will become obsolete. Personal information will not be required to establish identity: Personal information will remain private and secure, as it will not need to be transmitted. Private information will remain the property of each individual. Already existing quantum-proof encryption techniques will be standardized to replace current elliptic curve cryptography.

The newest biometric methods will be used for restoring one’s secure environment when personal devices are lost, stolen or damaged.

Reputation systems will allow people to create and expand their own personal networks, including trading networks, social networks and a host of other distributed services.

The impact on banking will be multi-faceted. Probably the most important aspect is that lending institutions using second-generation cryptocurrencies will not be able to take advantage of fractional banking. That will be a guarantee of currency integrity.

Currently a bank can loan a quantity of money to a customer independently of its reserves. However, cryptocurrency is uniquely traded and traced. For cryptocurrency to be lent out it must exist and must have been deposited in the lender’s account.

The gradual disappearance of fractional banking will move the responsibility for controlling the liquidity of currencies from central banks to automatic crypto-network mechanisms.

Currently, we rely on government economic indicators for taking the pulse of the economy. We further rely on humans in central banks evaluating those indicators and suggesting corrective actions within a certain time frame.

Crypto-networks will rely on a demand index calculated automatically. This is determined by the cumulative effect of people and businesses borrowing and repaying loans, from banks of anyone else, together with all the transactions processed by currency exchanges worldwide. This index, for each cryptocurrency, will be used by its native crypto-network to automatically evaluate the need for new currency and instantaneously issue new cryptocurrency when the economy is expanding.

Summary

In summary, the following will be important factors affecting banking:

1. Security tokens, a corollary instrument created on a crypto-network over and above its native cryptocurrency, will continue to replace other forms of instruments for investments.
2. Payments will not be any more an integral function of traditional banking.
3. The FED and Central Banks will have a reduced influence on the economy, as new currency is automatically generated and distributed directly to users.
4. Financial institutions will continue to evaluate and provide loans, but fractional banking will gradually disappear. They will be able to expand their services to customers by using virtual private blockchain networks; at the same time their customers will use public crypto-networks for communication, payments and other public services.
5. New government regulations will likely be developed to regulate exchanges and new services available with second-generation cryptocurrencies.
6. The KYC function provided by local institutions or by specialized companies will still be necessary for the initial distribution of new personal, blockchain-registered unique devices and for the provision of new special services.

The projections presented in this article are based on the current design of a stochastic crypto-network (GNodes). The disruption of crypto-mining, banking and current cryptocurrencies will be some of the most immediate side effects related to the fintech industry.

Society will benefit by being able to count on a distributed digital environment inherently secure, with verifiable contacts and reputable trading partners, convenient and fast distributed applications and many other services, making our lives simpler, safer, more creative and more enjoyable.

Blockchain and individual freedoms

Individual freedoms are important to most Americans.
We believe that some type of representative democracy is an insurance against dictatorship.
We value our freedoms and we believe that they are conductive to a free society, innovation, progress and a better standard of living for all.

It is apparent that when institutions public or private, are centralized and become more powerful they  attract
people interested in seeking power. The concentration
of power at the top of these organizations often leads to abuses of power.

The majority of people, who earn their reputation and remuneration in life by servicing other people are not interested in acquiring power and control over other
people. We all benefit when our neighbors and friends are happy, free, honest and successful.

The average person builds, creates, innovates, learns, solves problems, risks, invests and provides products and services to others, values other people freedoms, may be self-reliant or more social, may be hard working or highly productive.

If you are this type of person and do not seek to influence and control others, then probably your goal is not to be promoted through the ranks and eventually to the helm of a powerful, centralized organization. Those positions are instead filled with people who think they know better and seek positions of power and control over others. Only in rare cases, when they have developed a strong ethical philosophy that has been tested during their lifetime, such people may have the fortitude of caring about the opinions and individual freedoms of others.

It is not surprising then, that the average person has become resentful of centralized institutions: whether these write laws and regulations, establish the value of our currency, control the way we work, gather and use our private information through social media, or choose the news we are presented with.

Centralized institutions limit or infringe on personal freedoms in the following areas:

Misinformation and censorship

Americans have become more careful about the source of their news. With the pervasive use of the Internet, web news sites and social media sources have become more influential, and consequently more controlled by people with a political agenda.

Powerful sources may create news that conform to their agenda (misinformation), and block news that are contrary to their agenda (censorship).

While many independent sources can be found on the web, this usually involves some time and effort, while large news services are more visible, especially when the browsers we use are possibly biased and programmed by large organizations.

The entertainment industry, because of the large funding requirements for production of television programs and movies, still has a large influence on the masses.

Freedom of speech and freedom of religion are the first victims of centralized, influential
news services.

Privacy and Security

Large and influential institutions may feel they are above scrutiny and decide to gather and keep private information about their customers. Recently we have heard of several cases in which institutions and organizations have gathered private information without consent, or compromised private information. In other cases, account passwords have been stored in readable form and exposed to the company's employees.

Currency creation and distribution

Money is the representation of the work we do: products we create and services we provide. Since work occupies a major share of our life and earned money is a measure of that effort, money is important to us, not only as a means to acquire personal property, but also as a means to help others.

When the money supply is arbitrarily created and controlled, whether by the central banks or by regulations, the effects may be economic hardship for many and possible advantages for a few.

The Blockchain promise

Blockchain technology promises to help in all of the above areas, by providing the basis for

• a distributed design of news services and social media applications, so that people can have more uncensored sources available and can gauge the reputation and reliability of
  those sources;
• better security of private and personal information, whereby the unique identification of each person is assured and does not depend on releasing of private information; and
• an alternative currency not controlled by a central institution, but by an automatic algorithm, that can provide price stability. A currency that can be used as a fiat currency for invoices, loans salaries, and for trading worldwide.

However, ten years after the introduction of this technology in public networks, these promises have not been fulfilled. The few public networks that have maintained independence from large organizations (unpermissioned networks) have problems of scalability, efficiency and cost.

Bitcoin cannot support applications and its currency is volatile. Ethereum, which theoretically can support distributed applications, at this time has problems of scalability and cannot support a single application the size of a social network.

The good news is that a completely different approach is now been proposed to fulfill the blockchain promise. New, stochastic networks, using different designs and protocols, are on the way, solving the problems that have stalled blockchain technology for years.

The proposed network model is not de-centralized any more, but distributed and stochastic. In the distributed model, there are no classes of nodes and there are no intermediaries (miners, verifiers), but each node is equally involved in the verification of transaction and maintaining the security of
the network.

The proposed consensus protocols are also new: All current blockchain-based consensus protocols, more than sixty varieties of them, are leader-based. One node broadcasts the block to every other node. The proposed protocols are not leader-based but reach an agreement on the composition of the block among a majority of peer nodes.

This evolution of blockchain technology is described, for example, in the article at: https://medium.com/@gori70/blockchain-de-centralization-is-the-problem-79984bbf24f5

This transformation will solve the current problems of scalability and allow distributed applications with high data transfer requirement to use blockchain networks. Software development companies will be able to use a more functional distributed operating environment for their applications.

The blockchain will be replicated on all user devices. The advantages for users will be: usability, security and transparency.

These new developments will also open the way to the use of superconnectivity, the connecting thread between blockchain applications and the IoT world.

Stochastic, fully-distributed crypto-networks will soon fulfill the blockchain promises, revitalize the blockchain industry, disrupt crypto-mining industries, reduce energy utilization, provide an alternative to current crypto-networks and effectively revolutionize the distributed application world.

Giuseppe Gori is the CEO of Gorbyte (gorbyte.com), a blockchain research, development and innovation company. Gorbyte started researching distributed consensus models a few years ago and is currently developing GNodes, a new crypto-network that uses the first blockchain-based, distributed consensus protocol, called MARPLE. When MARPLE is used as a consensus protocol, all nodes participate in assembling the block, and in verification and security functions, without the need of intermediaries or monetary reward. Gorbyte is currently raising private funds through a security token offering STO in partnership with DealBox (Carlsbad, CA, USA) and TokenIQ (Phoenix, AZ). The funds are being used for the development of GNodes.

Blockchain: De-centralization Is The Problem

De-centralization is one of the buzzwords of blockchain technology: companies and web sites have sprung up that include this word as part of their name.

De-centralization has been touted as a most advanced feature in fintech. The acronym DLT (De-centralized Ledger Technology) has become a synonym for blockchain in the fintech permissioned environment.

Few realize that de-centralization is itself the problem. This concept has kept blockchain technology stalled for many years. Let me explain.

In the 1960s, computer systems were centralized, or configured as a star network. Only in the early 1970s did the need to connect computers from multiple manufacturers become urgent.

At the time, the nodes of the few existing communication networks were typically organized hierarchically, but from the very beginning the protocols implemented in the nodes of the ARPA, RPCNET, PISA and other groundbreaker networks preceding the internet were designed with the general idea that no central node or authority should control, lead, be the center of, or own the network.

In other words, we knew that a centralized, star, multi-tier network, with its innate bottlenecks, was not going to satisfy even the 1970's requirements of thousands of users. We also guessed that by reducing the number of bottlenecks through de-centralization the problem would be reduced, but not solved. We knew that a solution would have to use a distributed peer-to-peer model.

Since many organizations would be involved in the provision of nodes, links, possibly unreliable hardware and software, we had to assume that the network was unreliable. We did not know how a consistent set of data, or even a single transaction, could be maintained in multiple databases through an unreliable network when any node could generate a message or, in fintech terminology, a financial transaction. The problem was further compounded by the presence of deliberately malicious players.

Why blockchain technology has been hindered by the de-centralization idea

In general terms, we recognize that a network is de-centralized when the control of the network is shared among a subset of the network's nodes.

A network is distributed when all nodes equally share responsibilities and run the same node software.

De-centralized (permissioned and leader-based) networks were often extensions of centralized networks deriving from application requirements, for example by the fintech industry.

The blockchain network software (basic system software) should not be designed according application requirements, as these will change. We did not design the network precursors of the Internet and the Internet itself based only on the requirements of 1970's applications. We could not have predicted what industries would develop based on the ability to share information globally.

In the same way, the underlying blockchain network should be as general, flexible and scalable as possible. The permissioned, client-server, and private network requirements can then be considered as special cases of a distributed network, for example by using the concept of Virtual Private (blockchain) Networks.

Distributed networks are more likely to be independent of any specific physical structure. Nodes can dynamically connect to each other and random connection procedures could possibly be used. Consensus solutions implemented on distributed networks can also be unpermissioned, majority-driven and recursive.

Distribution, not de-centralization, should have been the main objective of crypto-network design.

Why we failed

The failure to investigate distributed consensus agreements partly derives from the 1982 formulation of the Byzantine Generals' problem which models how information integrity can be maintained in an unreliable environment. The Byzantine Generals problem has been studied by researchers for over thirty years.

The analogy of several allied army divisions holding a city under siege correctly assumed that no-one in the field could be trusted to deliver a message and that some of the generals themselves could not be trusted when issuing a command.

However, the formulation of the army analogy suggested at least two classes of troops: generals and soldiers.

Some people then restricted their thinking to a more specific case in which the generals issued commands that needed to be both carried to other generals and protected from tampering by attackers or traitors.

Eventually, this approach led to a limited definition of the consensus problem.

Leader-based consensus models such as Paxos and Raft were and taught in universities and adopted as models by designers of implementations of blockchain networks.

As a result, practical solutions of the Byzantine Generals problem focused on various methods for selecting a leader node, which would send a block of verified information to all other nodes, instead of seeking to achieve a consensus on the content of the block.

Missing the target

A consensus on which node should be the current leader does not solve the problem of trust. The current leader must be trusted. It must do the job of verifying and assembling blocks in a fair manner. Thus, the leader in current leader-based consensus protocols is required to provide some credentials: proof of work, proof of stake, proof of capacity or proof of anything else.

These "proofs" do not guarantee much more than a vested interest that leader nodes (or nodes aspiring to be leader nodes) may have in the network: the more interest they acquire, the less they will be willing to destroy their form of income.

These "proofs" guarantee that potential leaders have credentials, but do not guarantee that the information assembled in the block is correct, or at least that it has been verified by a majority of the nodes.

We have seen more than 60 proposed solutions based on leader-based models for various blockchain implementations. They suffer from a common fault: one node decides what every other node will store on the blockchain. The result is almost the opposite of what is required.

Summary of the disadvantages of leader-based protocols

Leader-based protocols have the following disadvantages:

• They do not solve the problem of trust. The leader node may introduce faulty data, intentionally or not, in the block of information.
• Rewards, associated with the work of verifying and assembling blocks, create an incentive for nodes to compete for the rewards and to be promoted to leadership positions. This incentive tends to create a special class of nodes. The network then morphs into a de-centralized network. For example, Bitcoin started as a network of peers where every node could verify transactions and compete for a reward. Today it is a two-class network (miners and users) and is controlled by large pools of owners.
• When the assembly of a block is left to one node, one of the major requirements of consensus theory is invalidated: the agreement is not based on a majority consensus about what information will be stored on the blockchain. The only agreement reached is the method for choosing a leader node.
• A bottleneck, or single point of failure, is introduced: One node has to broadcast a block to every other node.
• Efficiency is not the best: large blocks of data are more subject to transmission errors and re-transmissions of maximum size packets.
• Redundancy is almost 100%: Each transaction included in a block has already been received by every node separately, when the transaction was initially issued.

A better analogy

When thinking about an analogy for the problem of reaching a common decision in an unorganized and unreliable environment, we could have used an analogy of an army without ranks, but it would not have been very intuitive.

A better analogy could have been the challenge of deciding the daily closing price on a stock exchange. In this analogy, a multitude of buyers and sellers determines the daily closing price of stocks using a stochastic process, without any particular person taking a decision for anyone else.

In the stock market there is no "right" answer for a stock price, but just an agreed daily closing price.

Similarly, in the composition of a block several variables, such as the order of the transactions, can determine the final block composition. There is no "right" block composition, but just one that nodes agree on.

Consensus protocols based on a more distributed analogy could have avoided the tendency towards centralization and the requirement of intermediate nodes, typical of leader-based protocols.

Examples of intermediaries in a network are:

• Miners, producers or verifiers, volunteering or engaged to provide a service to the network,
• Special nodes of federated systems that have a stake in the success of the network,
• Nodes elected with some criteria to perform network governance,
• Nodes owned by trusted companies or institutions,
• Special players, such as centralized Currency Exchanges holding user wallets.

What's wrong with Intermediaries?

First of all, it is a question of cost: If the intermediaries are doing useful work, for example verifying transactions, then they need to be rewarded.

It is also a question of trust: customers using a network with intermediaries need to trust:

• that the intermediary is not giving preference to certain users or transactions,
• that the intermediary has not been, or will not be, taken over by a malicious attacker,
• that the intermediary's system is not experiencing a blackout, or targeted by a DoS attack, or experiencing a system failure, or any other cause that will affect or delay customer transactions,
• that intermediaries' system software and data are reliable, so that data integrity and security are guaranteed.
• that they are really connected to a trusted system and not to an impersonator (e.g., some other system pretending to be a trusted intermediary), and
• that no other unpredictable event will happen. Recently, for example, the owner of the Canadian currency exchange Quadriga died or disappeared. As a result millions of dollars of customers' funds are missing.

Finally, it is a question of data availability. If a network has a privileged or restricted class of nodes managing the blockchain, then the majority of nodes do not have immediate access to the current replica of the blockchain. This may preclude the development of real-time applications, such as automated trading applications.

Is it too late to change the model for blockchain consensus?

Most experts will tell you that a major function of consensus protocols is to maintain the security of the network. This view confuses two issues. Security is certainly needed, but it is a completely different requirement that can be solved by other means (and this will be the subject of a separate article).

Still, many developers are stuck with the ideas that consensus means choosing a leader and that consensus is needed to maintain security.

With hind-sight, if we had thought of a better distributed analogy, the research could have turned towards a different direction, suggesting stochastic approaches and possibly could have led us to the earlier development of better distributed solutions without intermediaries.

This is now an education issue, more than a technical issue. Most researchers, consultants and experts on crypto-networks are proficient in all the details of PoW, PoS, DPoS and several dozen alternatives, all based on the same leader-based model. The few solutions that are not leader-based, are not blockchain solutions: They are solutions in which each transaction is handled separately.

On the positive side, most people and 95% of companies, according to a recent poll, understand the potential of blockchain technology.

A transition, from a de-centralized to a distributed model, is urgently required to unlock the blockchain's true potential, to solve the problems of scalability and to run the blockchain on any user device without intermediaries.

Giuseppe Gori is the CEO of Gorbyte (gorbyte.com), a blockchain research, development and innovation company. Gorbyte started researching distributed consensus models a few years ago and is currently developing GNodes, a new crypto-network that uses the first blockchain-based, distributed consensus protocol, called MARPLE. When MARPLE is used as a consensus protocol, all nodes participate in assembling the block, and in verification and security functions, without the need of intermediaries or monetary reward. Consequently, the GNodes crypto-network does not include incentives that push towards centralization. Gorbyte is currently raising private funds through a security token offering STO in partnership with DealBox (Carlsbad, CA, USA) and TokenIQ (Phoenix, AZ). The funds are being used for the development of GNodes.