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Banks Embrace Bitcoin’s Heart but Not Its Soul

Major financial institutions like some technical features of Bitcoin but are building their own versions that leave out the digital cash and built-in economics.
September 24, 2015

In the depths of the financial crisis in 2009, someone using the name Satoshi Nakamoto launched a digital currency called Bitcoin that he or she claimed could remove the need to rely on central or commercial banks. Six years later, financial institutions such as JP Morgan and Citigroup are taking on Nakamoto’s ideas – but ditching the parts of Bitcoin’s design intended to reduce their influence.

Instead, banks such as Barclays and Credit Suisse are backing efforts to draw on Nakamoto’s open-source code to build systems that will help financial giants do business as usual more efficiently. The general plan is to build software that apes the way Bitcoin records and verifies transactions in a digital ledger known as the blockchain, but to do it without the digital currency itself, or the way its blockchain is secured and operated by a network of computers owned by various companies and strangers around the world running “mining” software (see “What Bitcoin Is and Why It Matters”).

One such project became public last week, when New York City startup R3 announced that it was partnering with nine banks including Goldman Sachs, UBS, and JP Morgan to develop blockchain software that could ease the transfer of financial assets between institutions. If an asset’s ownership is recorded by cryptographic software in a blockchain recognized by multiple banks, it can be transferred between them more rapidly than today, says Richard Gendal Brown, R3’s head of technology.

In theory, a system like that could be built on top of Bitcoin. But some of its features are not a good fit for the financial industry, such as how its blockchain is public, says Brown. “Customers tend not to want their private financial transactions visible to everybody,” he says. Instead, banks could get together to operate a semi-private blockchain, powered by servers distributed between them, and accessible only to trusted institutions, says Brown.

A report from Spanish bank Santander this summer estimated that “distributed ledgers” could save banks as much as $20 billion annually in infrastructure costs by 2022.  Such ledgers are hoped to be cheaper to operate than existing, often outdated, solutions to connecting financial institutions, and they could also prevent assets from being locked up for hours or days as deals complete.

Chain, a San Francisco startup that this month received $30 million in funding from investors including Nasdaq, Visa, and Citigroup, is on the way to implementing that kind of design. A handful of customers are already seeking partners to share blockchains for specific types of assets, for example to record transactions in shares of private companies (see “Why Nasdaq is Betting on Bitcoin’s Blockchain”). Adam Ludwin, a Chain cofounder and the company’s CEO, expects the first such blockchain to go live next year and predicts that his technology will ultimately help consumers move money or other “assets” such as loyalty points more easily, as well as benefiting banks.

Chain was founded in early 2014 to provide software for the nascent Bitcoin industry. But the company decided to switch to developing private blockchain technology after meeting with executives from Wall Street companies who made it clear that Bitcoin was not suited to large-scale financial services, says Ludwin.

For one, Bitcoin was designed to primarily support transactions in Bitcoin over the Internet, but Ludwin found that financial companies didn’t care much for the currency. They were interested in better ways to move their existing assets around. Another problem was the volume and speed of transactions. Bitcoin’s design currently supports only roughly seven transactions per second. On average, it takes a new transaction 10 minutes to be added to the blockchain. And the total value of all Bitcoins today, underpinned by its blockchain, is $3.4 billion, a small figure to large banks.

Private or semi-private blockchains can be designed to specifically support whatever asset needs moving around, whether it’s stocks, bonds, or airline miles, says Ludwin. He claims they can also offer better security.

The network of computers running Bitcoin-mining software protects the blockchain against fraud, and is one of Nakamoto’s most innovative ideas. But anyone can join that pool of miners, and an organization with enough computing power could overpower the other miners and tamper with Bitcoin’s blockchain (see “Academics Spy Weaknesses in Bitcoin’s Foundations”). “Pushing U.S. stocks or other assets into the Bitcoin blockchain and hoping that, say, China doesn’t attack it felt like a stretch,” says Ludwin.

An older startup, Ripple, has attracted several small banks from the U.S. and elsewhere, and cross-border payments company Earthport to its own private, Bitcoin-inspired system (see “Making Money”). IBM, which has a sizeable business providing backend systems to banks and major corporations, is also exploring how blockchains could help the financial sector and other industries.

Moves from Wall Street giants to take selective inspiration from Bitcoin comes at a time that Bitcoin’s own community faces a major crossroads. Despite wide recognition that Bitcoin’s design needs to be modified or extended to support more transactions, there is vitriolic argument about exactly how (see “The Looming Problem That Could Kill Bitcoin”). There is no accepted governance or process for how to make such decisions about Bitcoin (see “Leaderless Bitcoin Struggles to Make Its Most Crucial Decision”).

Some people think Bitcoin will overcome that challenge and ultimately sideline the idea of private, Bitcoin-free blockchains. They offer a safe way for existing banks to dip a toe into Bitcoin-style technology today, but won’t ultimately go anywhere, says Barry Silbert, CEO and founder of Digital Currency Group, which has invested in more than 50 Bitcoin and digital-currency-related companies. He previously founded Second Market, which facilitates trades in private company stock, among other assets.

“We’re likely going to see years of exploration and talking and some preliminary products with companies like Chain, but it’ll be a very narrow use case,” says Silbert. He predicts that in coming years Bitcoin will rise to become a recognized store of value of something like gold, and that innovation in its design and services built on top will see the original, public blockchain become an underpinning for financial services of all kinds. “Eventually Wall Street will come to appreciate that the Bitcoin blockchain is the most secure and most flexible and can solve a lot of the issues that they have,” he says.

Ludwin also thinks Bitcoin will survive, but he says it will only represent a fraction of the value of less-radically open blockchains. Nakamoto’s invention will persist as a kind of backstop that offers a way for people unable to use or trust more conventional financial systems to move money around, he says. “The encroachment of other asset classes is actually bad for that; we need Bitcoin to thrive at that level,” he says. “The long-term vision is where we have many blockchains that are interoperable, as opposed to a single chain where everything is wedged in.”

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