The Case Against Editable Blockchains

Brian Kelly is an investor and financial markets commentator, founder and CEO of BKCM LLC and one of the founders of PAR, a blockchain-based hedge fund administration system.

In this opinion piece, Kelly argues that making blockchains editable allows users to rewrite history, therefore opening up financial systems to the potential for fraud.

A once-in-a-generation opportunity to upgrade our defenses against financial fraud is under attack. The immutable ledger, at the heart of bitcoin and blockchain technology, prevents bad actors from changing the record.

Accenture has patented a new type of blockchain that allows pre-selected parties with access to the ledger to edit entries, claiming its prototype will be more attractive because it will allow information to be changed or deleted.

Bitcoin and its technological innovation – a blockchain – have been heralded as the cure for what ails our antiquated financial infrastructure. I believe that the immutability of a blockchain is a key feature and strength in the technology.

Allowing anyone to amend or delete information from the ledger threatens our ability to fight improprieties with the game changing blockchain technology.

The importance of permanence

Since 2009, there have been more than 155 million bitcoin transactions. Every single one is permanently stored on bitcoin's ledger.

Every time a slice of pizza has been bought or hotel room has been booked on Expedia with bitcoin, a permanent record of the transaction is stored. Don't worry, none of the specific details – like how many slices of pizza you bought – are stored forever, just the record that a transaction took place and that value was exchanged.

Richard Lumb, Accenture's group chief executive for financial services recently wrote:

"That permanence has been vital in building trust in the decentralized currencies, which are used by millions of people … The financial services industry needs to face the question of how to balance the appeal of pristine accounting with the demands of the real world, where some things simply need to be struck from the records."

These two statements are at fundamental odds with each other and highlight the exact reason bitcoin was created. The moment you allow someone to change the record you begin to erode trust. While the change may be for the most benign reasons, like human error, it invariably opens the door to the erosion of trust.

The foreign currency markets provide numerous examples of what can happen once trust becomes corroded. From 1975 to 2007 – the post-Bretton Woods period when foreign currencies were set free to float with only the promise of a sovereign backing – there have been 201 currency crises globally.

What's even more striking is that over a nine-month period in 2008-2009, 23 countries experienced currency depreciations of 25% of more – the accepted definition of a currency crisis. The proximate cause of this cluster of crises was a loss of trust.

Bitcoin emerged from the rubble of the Great Financial Crisis as an answer to the loss of trust. The innovation of bitcoin and the blockchain is that it is a system that does not require trust to operate.

Upgrading the system

In order to achieve this state of trustable grace its underlying record of transactions must be immutable.

We need this technology to upgrade our aging traditional financial infrastructure. In fact, in the recently released paper, the World Economic Forum concluded:

"Distributed ledger technology (blockchain) has the potential to drive simplicity and efficiency by establishing new financial services infrastructure and processes."

The need for an upgrade to our existing financial plumbing is indisputable and the immutable blockchain is an integral part of this advancement.

A blockchain is a tool – like a hammer – sometimes you need a sledge hammer and other times you need a rubber mallet. There are ways that the prerequisite of permanence can be reconciled with the "demands of the real world".

For example, at BKCM we are using blockchain technology as a tool to build our PAR System – a disruptive hedge fund administration system.

We recognized that a blockchain was the perfect tool to track inflows and outflows of money in capital pools. The proper accounting for investments in hedge funds is not something that you would want to be edited. It was the ability to change the permanent record that enabled Bernie Madoff to commit the largest fraud in financial history.

In my view, for blockchain technology to move beyond "lab experiments", it is critical that we embrace the features of immutability and use the tool for its intended purpose.

A blockchain is a great way to keep a record that you don't ever want changed – this is the heart and soul of a trustless system – it is a feature, not a flaw.

Fraud image via Shutterstock