Control, security and 12 more unresolved blockchain problems

Alpina Publishing House has released the book “Blockchain for Everyone. How cryptocurrencies, BaaS, NFT, DeFi and other new financial technologies work” by Doctor of Economic Sciences Artem Genkin and expert in the field of digital technologies Alexey Mikheev. We are publishing, with minor abbreviations, a chapter that talks about some of the fundamental problems that still hinder truly large-scale implementation of DLT.

Then why did this reasonable idea cause such a flurry of discussions? Firstly, because bankers are generally timid and they need to constantly be afraid of something - electronic money, cryptocurrencies and other phantoms...

There are a number of opinions about what the main obstacles are hindering the development of blockchain. Thus, O. Kurchenko notes low awareness (despite all the hype around Bitcoin and blockchain, in fact, only a tiny percentage of the world’s inhabitants are involved in these innovative technologies), the lack of uniform standards and rules, a clear regulatory framework, a lack of professional legal expertise, digital inequality, lack of all-inclusive solutions, low liquidity, problems associated with anonymity and pseudo-anonymity.

According to a 2020 Deloitte survey, many organizations now recognize the need to address blockchain-related accountability issues, particularly those affecting customers, suppliers, investors, regulators, government agencies, and society at large. Areas of concern also include cybersecurity, global digital identity, accounting, auditing, internal controls, tax and financial reporting compliance, governance and the implications of the continued growth and development of the digital asset sector. Organizations and countries that do not learn to solve these problems will eventually lose their market share.

According to the BIS, the risks of using DLT include: operational and safety uncertainties arising from the technology, lack of interoperability with existing processes and infrastructures, uncertainty regarding final settlements, regulatory challenges of implementing DLT, lack of an effective and reliable system management and issues of data integrity, immutability and confidentiality.

Let’s try to break down the problems that arise when implementing blockchain into several main types (although this is not easy).

Intra-industry problems

Blockchain must overcome many challenges to become a mainstream technology. One of the key ones is related to technology development and management. Without a set of standards that can ensure systems are interoperable across industry and supply chains, the technology will be difficult to scale. It needs to be consistent with legacy systems, as well as private and public blockchains. Developers must provide a roadmap for the development of blockchain, in particular to increase the flexibility of smart contracts, distribution and increase the security of the technology.

A 2019 Gartner report cited the lack of standardization of blockchain platforms as a major problem. In addition, today the blockchain platform market mainly consists of disparate offerings that often overlap or complement each other, making it difficult to choose a specific technology.

Blockchain enthusiasts and pioneers often used complex language and technical jargon to explain its essence. As a result, users still do not understand how blockchain functions and what advantages it has over other existing technologies. It is necessary to demonstrate these benefits with specific, practical business examples.

Problems of personnel and competencies

Lack of sufficient digital skills will be a barrier to blockchain adoption, especially for SMEs and micro-enterprises with limited financial resources. Large players acting as hubs of blockchain competence will have to “pull up” their supply chain partners. However, there is a risk that differences in digital skills could push SMEs out of the digital supply chain. Often, implementing a blockchain solution requires a full-scale reorganization of the business processes of an enterprise, and sometimes the entire sector.

Critics also noted the poor blockchain literacy of consumers and their distrust of the technology.

The main obstacle to the widespread adoption of blockchain technologies remains the need to ensure ease of use. Lack of knowledge and technical skills prevents some groups of citizens from using blockchain.

Regulatory factors

There are also regulatory issues. Blockchain is often based on a multi-party, cross-border architecture, spanning many regions with different regulatory regimes.

The laws of many countries and regions directly affect the use of blockchain, even if the legal regulations are not directly related to it. An example is the General Data Protection Regulation (GDPR), which regulates privacy issues in the EU.

70% of respondents to a 2020 Deloitte survey believe that regulatory changes in the blockchain space are happening quickly or very quickly. With a growing number of regulators concerned about the potential risks of blockchain, the regulatory framework for the technology has become uncertain and unpredictable across jurisdictions. A significant portion of stakeholders consider regulatory uncertainty to be the main obstacle to technology adoption.

Cybersecurity issues

66% of respondents to a 2020 Deloitte survey believe that cybersecurity issues could prevent widespread adoption and use of blockchain as a major concern.

It would seem that blockchain with its cryptography offers a certain degree of protection for the platform from cyber attacks. And the distributed nature of the blockchain implies a degree of transparency that will allow attacks to be quickly detected. But even such a system is potentially vulnerable to attacks that can come from any key access point to it. It may be that advances in quantum computing will be able to overcome the existing cryptography techniques that secure blockchain platforms, breaking all public key encryption algorithms.

Possible technical vulnerabilities of blockchain projects are well described in an article published on Habr.

Business use of corporate blockchain systems creates additional risks. According to Positive Technologies, 71% of pilot projects for the implementation of blockchain systems had vulnerabilities in smart contracts, and half had vulnerabilities in applications for accessing data on the blockchain. And for a successful attack, only one vulnerability is enough, because the blockchain system manages critical data

“The consequences of attacks may include: unauthorized entry of data into the registry, attacks on users from the blockchain, and complete blocking of the system. Hypothetically, this could lead to an attacker gaining complete control over the organization’s critical resources,” says Arseny Reutov from Positive Technologies.

“Cyber ​​attacks on blockchain solutions will grow rapidly as these systems emerge, especially those that automate mutual settlements and other financial processes and tools,” believes Artem Kalikhov from Waves Enterprise.

Many companies, when creating a blockchain solution, pay little attention to security. Meanwhile, an audit of blockchain solutions would help identify vulnerabilities in advance and protect users from attacks.

In the event of a hacker attack on a public blockchain, there are two main solutions: either a hard fork or rolling back the state of the blockchain before the attack and adding new transactions only from that moment (but then all transactions made after the incident will be lost and will have to be added again) or accepting the consequences attacks.

Technical challenges inherent in blockchains

Blockchains tend to consume a lot of memory. Decentralization, in which each participant in the network stores the same information, as well as the natural increase in the number of transactions, can lead to the amount of available memory being insufficient.

The speed of processing transactions on the blockchain is extremely low compared to traditional payment systems. In terms of performance, blockchains are significantly inferior to traditional databases, since the cryptographic component, which, in fact, gives the blockchain such important advantages, involves complex calculations.

Blockchain's consensus-based verification mechanisms require significant computing power and can slow down transaction speeds as the need for data storage increases. This is a major technical obstacle to the scalability of a blockchain system and achieving economies of scale.

Each network decides for itself which of the three properties (scalability, security and decentralization) is its priority. This is the so-called blockchain trilemma: only two of these three properties can be fully realized at the same time. Scalability is the ability to process a larger volume of transactions. Security is the reliability of storing data in the blockchain and preventing its falsification. Decentralization is the degree to which control of a network is distributed. Altchains are an attempt to solve the “blockchain trilemma”.

Overall, blockchain technology is immature in terms of scalability and is still struggling to handle large numbers of transactions.

Authors of the study “Blockchain Risks. Recommendations for Professionals”, conducted in the spring of 2021 by the ISACA and AICPA & CIMA associations, identified five main groups of risks for private blockchains: those arising during the development stage, infrastructure (related to the exchange and transmission of data), risks within the framework of security key management, and vulnerabilities of smart contracts.

The study details each group's potential vulnerabilities and their consequences. For example, insufficient security key security jeopardizes the safety of digital assets. And due to the insufficient number of protocols for unconfirmed transactions, it becomes possible to carry out fraudulent transactions that were previously rejected.

Thus, a matrix is ​​formed that a business can use to assess and prevent potential risks when implementing blockchain.

J. Bloomberg, in the article “Don’t be fooled by the hype about blockchain, which reduces costs,” cited a number of disadvantages of blockchain:

• Instead of justifying the retirement of mainframes, blockchain is provoking banks and other businesses to double down on their investments in mainframes. In fact, mainframe leader IBM has bet on blockchain on its mainframes. However, the question remains to what extent such a mainframe-centric approach to blockchain, meeting the needs of the banking industry, can deliver cost savings as a key benefit.

• Since blockchain has a distributed architecture, it requires multiple processing nodes spread across multiple participants, which increases overall transaction costs and also introduces scalability and performance issues.

• A chain is only as strong as its weakest link, which is equally true for blockchains. If one node has performance, scaling, or security issues, they can impact other nodes.

• In addition to energy resources, blockchains consume storage resources, the requirements for which will always increase due to the fact that each individual node must maintain an immutable ledger of all transactions.

J. Omaar, in her blockchain database development model back in 2017, calculated that the cost of storing one gigabyte of data for a Bitcoin network node would exceed $22.7 million, based on current operating costs.

Laurie Heino-Reuer, director of business development at Daimler Trucks North America, sees some potential risks to the industry's adoption of blockchain:

• Given the immutability of blockchain, data entry is inherently susceptible to human error.

• If a company's private key is damaged or misplaced, the blockchain will become unverifiable and massive data loss will occur.

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Unconfirmed transactions and mempools

With the growing popularity of cryptocurrencies, the number of transactions added for validation increases and so-called mempools are formed - a set of all transactions awaiting confirmation by miners on the network. Transactions are queued to be added to a block for processing. The higher the commission set by the sender, the faster miners will include a record in the block. As a result, fees are constantly rising, and transactions with low fees can wait several hours or even days for confirmation. For small transfers, the commission can be several times the transaction amount.

When Bitcoin's mempool grew to 200,000 unconfirmed transactions after the Bitcoin price soared in December 2017, many popular crypto exchanges could not cope with the load. Users had to pay high fees, up to $32 per transaction, to avoid delays in confirmation.

High-cost nature of the technology

Another critical issue is the potentially high costs, both financial and organizational, required to implement blockchain technology, even at the pilot stage. Companies have to weigh the potential benefits of implementing blockchain against the costs of testing specific cases, including integration with legacy systems, and take into account the shortage of qualified personnel to implement blockchain projects. Consortia are being formed to mutually distribute costs when creating and using blockchain infrastructure, but issues of coordination and conflicts of interest remain.

Like any IT project, DLT requires investment in infrastructure, development costs, consulting costs, R&D costs, and labor costs through direct hiring or outsourcing to BaaS providers.

Risk of centralization

A. Seyun notes: despite the characteristics of open source and a peer-to-peer network, blockchain technology without a body or institution regulating actions in the system can lead to the emergence of a new oligarchy and a polarized society. In addition, in current cryptocurrency networks there is already a tendency towards centralization or elitism.

M. Atzori reminds: “In theory, an open source protocol is designed to facilitate collaboration on a global scale, and everyone can contribute to the development of the code through an online forum (github.com). In practice, however, decisions are made by a small number of core developers, and they constitute a management group with exclusive authority to accept applications."

However, actual adherence to the principle of openness may be questioned, since individuals or organizations having the technical know-how to perform these functions allows them to participate in setting up complex aspects of blockchain technology, so that the “core developers” retain most of the control. Thus, “the revolutionary potential of network management as absolute, completely horizontal [i.e. e. non-hierarchical] mode of political and social organization is often exaggerated and unrealistic.”

Industry challenges when implementing blockchain

D. Sachdev notes a number of problems that arise when using blockchain for supply chain management (SCM).

First of all, there are security issues: DRM transactions are private, and the user wants his identity to be known only to trusted partners. However, the Bitcoin blockchain is a public ledger whose transactions can be viewed by all participants. Bitcoin is a pseudo-anonymous system: even if only the owner's address is used in a transaction, the user's identity can be identified by analyzing the labeled data.

Another challenge is role-based access control: in a permissioned environment where new partners are constantly being added to the supply chain, it must be possible to define write and update access to the blockchain at the group user level.

In addition, IoT automation must provide petabyte-scale data storage for supply chain partners. However, the data must be labeled using user-defined metadata so that it can be easily discovered by other users.

Blockchain can guarantee the origin and integrity of data, but not the identification of its rightful owner. This leads either to the entry of incorrect data or to the illegal owner claiming rights to the data. As an example, farmers can interfere with data input from IoT devices by installing physical barriers: if the sensor is covered with an umbrella, the climate information will be distorted. And, for example, if a sensor measures tire pressure, then the owner of this data may be a tire company, a car factory, a car dealer, an insurer or a car driver.

Problems of blockchain consortiums

The emergence of new blockchain consortiums around the world is further driving the adoption and implementation of blockchain-based solutions.

In terms of governance and structuring, blockchain consortia have emerged with four key areas of concern: decision making and authority, financing and revenue distribution, legal structures and risks, and intellectual property and ownership.

A Deloitte study found that many consortiums with a common goal to succeed in blockchain-related endeavors often fail due to internal infighting and inequities in addressing these problematic issues.

At one time, John Matonis, director of the Bitcoin Foundation, said that a private blockchain run by banks could lead to the creation of just “another cartel” and would work just as poorly as a payment consortium.

The problem of the limits of freedom of speech

Italian developer Alessandro Cegala has stopped working on his applications and publicly announced his diverging path from DLT. The reason is that he sees the dangers created by unlimited freedom of speech, and does not want to technically help it. “Given previous experience, it can hardly be assumed that decentralized technologies will not become the Wild West in the worst sense of the word,” the developer concluded. As an example, he cited a video hosting platform running on the blockchain, which, according to him, is full of dubious content dedicated to weapons, conspiracy theories, advertising of cryptocurrency pyramids and pornography.

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The problem of conflict of interest

The introduction of blockchain into the banking sector is paradoxical. Investments in blockchain could disrupt the existing business model of banks. If blockchain lives up to expectations, banks will be able to provide services faster, cheaper and easier, which will lead to a drop in their income, which is not profitable for them. In addition, millions of jobs could be at risk.

In the summer of 2018, the Boston Consulting Group (BCG) presented a rather skeptical report on the problems of implementing blockchain in the retail network. The authors of the report believe that it is not yet clear whether the transition to a blockchain platform is justified from an economic point of view and whether merchants are ready to accept blockchain, which can reduce the already small share of profits (eliminating the pricing inefficiencies and uneven distribution of information that underlie intermediary fees). At the same time, according to analysts, the use of blockchain can increase the transparency of operations and create a more efficient and liquid market.

Privacy and digital divide issues

At the national blockchain conference “Blockchain/Finance 2021,” Artem Genkin noted: “Today it has become legitimate to pose the question somewhat differently than before, when blockchain was seen as a panacea... Could this technology be on the side of good or evil, on the side of financial inclusion or digital inequality? » DLT can strengthen and make the so-called digital divide more difficult to overcome. The social ranking system in China, which also becomes a way to control access to financial services, when used within its framework of the blockchain, provides access to social credit data and their tracking at the national level. Depending on the social rating, we may be talking about restrictions on concluding transactions with certain counterparties, types of assets, on access to financial resources, and even on employment. A powerful tool for social impact is being formed.

Blockchain technology could spawn many private social ratings. The impetus for their creation was the coronavirus pandemic. It is the “immunity passport” that can stimulate the accumulation of extensive biomedical data about a person, along with information about financial transactions and activity in the social sphere. At the same time, a person will have full civil rights only by agreeing to be a source of big data. Viktor Dostov shares the opinion that an order of magnitude more information is already being collected about a person than before, and technology really opens up many opportunities for tracking and control - from analyzing profiles on social networks to studying cash receipts.

In this context, it is of particular importance to check whether the objectives and purposes of collecting such data are not discriminatory, as well as the ethical assessment of any technological decisions that imply restrictions or provide benefits to users. In the end, blockchain technology itself is neutral, reminds Artem Genkin: “The nuances of application are important: in biased hands, the technology will increase, rather than reduce, digital inequality. You have to be very careful here, ethics are primary here.”

Concerns about the privacy of settlements in connection with the prospects for the introduction of the digital euro were expressed by both market professionals and the EU public, recalls Dmitry Kochergin, a professor at St. Petersburg State University. For consumers, payment privacy is much more important than security. As the expert explains, due to its programmability and traceability, digital currency technology implies increased control over the circulation of funds. This dramatically increases the degree of supervision and control over citizens’ spending.

Other problems

Interoperability is another fundamental challenge that needs to be overcome, as the most likely scenario is that many different public and private blockchain platforms will emerge that will require some kind of interoperability.

The very fact that no one can easily delete or change information from the blockchain is contrary to several EU laws such as Directive 95/46/EC or GDPR.

Implementing blockchain as a trust mechanism is also a risk. Blockchain, for all its benefits, does not replace institutional trust and infrastructure.