Interoperability—the buzzword for 2020

Over the past few years, crypto entrepreneurs have been engaged in a race to create new and better blockchain based payment and value transfer innovations. The blockchain technology makes it possible for those with the knowhow and the funding to create tokens or cryptocurrencies that can change our way of life for the better.

Indeed, cryptocurrencies have challenged the traditional pillars of the financial system in ways that were inconceivable just a few years ago. Competition-driven innovations in cross-border transfers, micropayments and new payments instrument offerings are profoundly affecting the way people pay, save and transfer value.

Enterprises too are developing or adopting blockchains that enhance transparency and efficiency. The deployment of such blockchain based solutions has the potential to improve a company’s profitability, something beneficial to stockholders.

The problem

Yet in spite of all these positive attributes, it is also becoming apparent that the ultimate success of these innovations will depend on the ability of blockchain networks to interact with each other.

There are probably hundreds of public and private blockchains that exist largely in isolation, thus unable to exchange information or value with one another. This problem is best encapsulated by challenges that early users cryptocurrency faced each time they attempted to switch from a crypto platform to a fiat one.

During those times, very few people were knowledgeable about the blockchain, the associated cryptocurrencies and their potential. This heavily curtailed the use of the technology as a medium of exchange, a vision of the founding creators of cryptocurrencies.

However, as the value of cryptocurrencies like that of Bitcoin began to rise, so did interest and knowledge about privately issued digital currencies. Suddenly there was a growing need for the support of cross platform exchange of value.

Sadly, some conventional financial institutions would for various reasons, block any switch from crypto assets to fiat. This meant that early crypto users were left ‘trapped’ with financial assets, which could not be liquidated. This challenge emerged as one of the significant barriers to broader adoption of cryptocurrencies.

While the problem still exists, great strides have been made in ameliorating this. Today many crypto exchange businesses and devices created to solve this challenge now subsist.

In spite of this progress, some organizations still baulk at the idea of developing or adopting blockchain solutions because there is presently no smooth interaction between different blockchains. Different blockchains are operating as silos; there is no interconnection or a technology layer that act as a bridge between them.

For instance, a company which stands to gain significantly from the use of the Hyperledger—a blockchain solution for enterprises— will avoid adopting this technology if it becomes clear that the company’s immediate suppliers or service providers will not use the same.

This lack of standards or interconnection between different blockchains could be the one significant barrier slowing down the adoption of the technology.

Usual path of new technologies

Now for those familiar with the progression patterns of new technologies, the gridlock that seemingly exists in the blockchain market is not entirely a new phenomenon.

As has been the norm with other information technologies, the initial versions of the blockchain or distributed ledgers appear to be more focused on core operations and functions hence the difficulties encountered.

The layers of usability in blockchain technology will indeed come but not as part of the underlying technology infrastructure or protocols, but rather, as a layer that stands besides, or on top of the core operational technology.

This important separation enables the underlying technologies to excel at what they are good at while relinquishing usability to a layer or protocol that is specifically designed for that purpose.

To better understand this one has to look back at the history of computers or the internet. The first computers had text only command lines with complex command structure and it was only after graphical user interfaces came along that a broader adoption would ensue.

Similarly, the Internet started as a protocol that required initial users to be technically savvy. However, the coming of the Hypertext Transfer Protocol (HTTP) enabled an ease of use through web browsers and this drew in the less sophisticated users to the internet.

Now there is a growing appreciation of the same within the blockchain space. There is a need for a usability layer that simplifies cryptocurrencies and the blockchain or simply put, the blockchain industry needs to be interoperable if it is to move forward.

It is this weakness (of blockchain networks) that has spurred some organizations to work on different projects attempting to simplify cryptocurrency use without necessarily disturbing the core operational technology.

Foundation for Interwallet Operability (FIO)—a consortium of leading wallets, exchanges, and crypto payment processors—is one such organization.

Why interoperability

For FIO, interoperability is one of the most critical challenges that need to be solved in order to drive blockchain adoption.

Through its whitepaper document, FIO presents what it calls a decentralized Interwallet Operability Protocol (IOP), a technology that acts as a service layer enabling homogeneous usability across all other blockchains.

The IOP enables wallets and crypto exchanges to very easily enhance user experience with industry standardized features like wallet names and request flow, while not encumbering underlying blockchains with complex integration projects and allowing tech geeks to focus on core blockchain technology instead.

While the FIO proposition does not yet qualify as an industry wide consensus, it does at least serve as an indication of a growing realization within this industry that without this layer, a broader adoption of the technology will remain elusive.

As expected, this IOP proposal is only attempting to solve the challenges faced by private cryptocurrency issuers or the exchange businesses, which is just one part of the problem. Public enterprises, central banks and non-currency issuing private enterprises that use the blockchain face a similar predicament.

Broader interoperability

The rapid growth of the blockchain market makes it difficult for different players to reach a consensus on what should constitute the industry standards, how any such standards should be enforced and by whom.

Again, this is to be expected of any emerging industry which is at very early stages of growth. Sometimes it takes efforts of one or a few individuals or a single company to kickstart the process of simplifying or standardizing a technology.

Now in what may appear as a start of such a process, Vottun, a privately owned technology company, says it has created a layer that caters for the broader blockchain industry. As Vottun correctly notes, there is no built in cross-chain mechanism in most blockchain platforms to enable the seamless transfer data between different blockchains.

This happens because the blockchain technology itself is specifically built to assure security and immutability, something that actually prevents this cross chain transfer of data from happening.

In spite of this challenge, more and more business processes will demand this cross-blockchain interoperability to execute contracts successfully across enterprises and industries.

Payment processes are increasingly cross border in nature and do require process integration across multiple enterprises for payment verification and settlement.  Similarly, supply chain processes require the tracking of material movement something which could include multiple participants, industries, and blockchains for both public and private record keeping, transparency, verification, and immutability.

To solve this challenge, Vottun says it has built an interoperable ‘blockchain agnostic’ protocol with high performance and scalability built-in. This suggests that Vottun’s protocol can interact with multiple public and private blockchain simultaneously, in real time, with high performance and scalability regardless of the blockchain network.

Different solutions for different clients

It is true that consumers or users have preferences that may have nothing to do with the prominence of a particular solution but everything to do with the local environment. For instance, Hyperledger is believed to be the most popular blockchain solution of choice for many American enterprises yet in Spain the picture is quite different, many enterprises and government organizations reportedly prefer Alastria

Quorum from JP Morgan is very popular within financial services industry. Clearly, customer or consumer preferences are what drive the ultimate design of a blockchain based solution, therefore it is only then natural that different blockchains will find it hard to interact with each other.

Vottun says its protocol guarantees that its clients will still run the same code developed for any of the blockchain solutions mentioned above on any of the other blockchains without changing the code.

In a sense, Vottun’s technology layer as well as FIO’s proposition, are the equivalent of what HTTP—which also began as a proposition—ultimately did to the internet. The two solutions attempt to make it easier for the less tech savvy users or organizations to adopt the blockchain without worrying about complexities behind the technology.

Indeed there may be more organizations aiming to do the same (the creation of usability layers), yet it is only when potential users become aware of such solutions will they become encouraged to adopt this innovation in greater numbers.

It is going to take a lot more than just the efforts of private individuals or organizations, for the world to see a broader adoption of blockchain related innovations. Public institutions like central banks will need to be in on the act as well if there is any hope for a quicker mass adoption.

Central banks digital currency interoperability

Central banks already have the means and influence—albeit a waning one—to engineer a mass adoption of financial technologies, which hitherto has not been forthcoming.  Indeed, the modest success of privately issued cryptocurrencies is evidence to the declining power and influence of central banks.

As consequence of this (cryptocurrency success), central banks remain generally disdainful of privately issued currencies as these fall outside their regulatory ambit, a point easily gleaned from a recent Official Monetary and Financial Institutions Forum (OMFIF) and International Business Machines (IBM) study survey.

It is quite perplexing then that some central banks to still believe this function (currency issuing) should only be reserved for them.

In fact, headstrong central banks should be concerned of reports that some of their peers are actually forging ahead with plans to issue central bank digital currency (CBDCs). For instance, the likes of RiksBank of Sweden and the National Bank of Cambodia are already piloting CBDCs and more are expected to do the same in the coming year.

Nevertheless, some of the few central banks that are embracing the blockchain, have expressed concern potential problems that may result once CBDCs begin to take root. Potential problems are likely to be more profound with respect to cross border payments as the OMFIF/IBM study survey suggests.

Part of OMFIF/IBM notes the following:

“Over the past two decades, domestic retail payments in economies across the globe have become more rapid and efficient, with many countries providing 24/7 payments with minimal settlement time. (However), the picture is bleaker for cross-border payments, which remain cumbersome, expensive and slow.”

 It may well be in this context, that some in the central banking orbit are arguing for the inclusion of capabilities to interact with different digital currencies that share the same design. They hope this will pre-empt some of the predicted crises should the majority of central banks go this route.

Interoperability of CBDCs between different jurisdictions could yet yield significant efficiency gains, for instance, by reducing reliance on costly correspondent banking networks and pre-funded nostro and vostro accounts.  The transfer of remittances is a case in point.

The case for remittances

To illustrate, a report by the World Bank states that global remittances were valued at $689bn in 2018, the largest type of person-to-person cross-border retail payment. More than three quarters of total remittances went to low and middle-income countries, representing a substantial source of revenue for the concerned countries.

Currently, retail cross-border payments such as remittances go through banks or via the slow money transfer services like Western Union or MoneyGram, which charge high fees, using Swift messaging.

However, there have been some changes which have greatly altered or affected the handling of cross border remittances.

The study survey adds:

“(While) Swift benefits from its network, scale and reliability, it still uses correspondent banking networks, which derisking has weakened. Since the (2008) financial crisis, banks have been reducing the number of their correspondent banking networks. This squeezes efficiency in cross-border payments. Money transfer organizations subsequently face greater costs, which are then passed on to the customer. “

Interoperable retail CBDCs should easily overcome this challenge if all central banks come on board with this.

Payments into a country using a CBDC would go from the payer’s account or wallet to the central bank of the receiving country and then directly to the payee or directly to payees’ wallets if it were peer to peer, without having to go through a network of commercial banks.

If both countries were to issue an interoperable CBDC, payments would only need an exchange market to function across borders. Increasing the number of cross-border payments systems could fortify financial stability by creating multiple levels of redundancies. Any form of failure of one payments system would not be harmful to the others.

Interoperability of all forms of digital money

One central bank quoted in the OMFIF/IBM survey, suggested that its own research had shown that in the long term, efficiency gains exist for cross-border payments provided that its CBDC would be interchangeable with other forms of electronic money. These new “rails” would reduce the reliance on correspondent banks.

The interchangeability of CBDC with other money forms, including privately issued cryptocurrencies, is the ultimate dream for cryptocurrency/digital currency users. A user should not—and rightly so—be concerned about the disagreements or the turf war between central banks and private issuers of currencies. A user’s only concern is making payments using a currency of their choice.

In any case, privately issued cryptocurrencies gained prominence because they identified and managed to service a niche that central banks have failed to serve for decades.

Also, it is important to remember that it was (and it is still) the threat from privately issued cryptocurrencies that cajoled central banks to contemplate issuing own CBDCs or into reforming in first place.

It stands to reason therefore that the continued presence or existence of privately issued cryptocurrencies will only have positive influence central banks in the long term. Interoperability between central banks’ blockchains and those of private players is beneficial for the great cause; the adoption of the technology.

Austria economist and Nobel Prize winner, Friedrich Hayek summed this up when he asserted that competition between currencies issued by private banks or players would ensure that only currencies guaranteeing a stable purchasing power would continue to exist. Alternatives that fail at this naturally be driven out of business.

While Hayek’s above assertion narrowly focuses on currencies, his argument is ultimately applicable for the entire blockchain industry.

The network effect

In fact, central banks, private cryptocurrencies issuers and other players in the blockchain space have an interest, an obligation in seeing that interoperability of blockchains becomes a reality because it ultimately benefits everyone. 

So while there may be challenges towards making interoperability of blockchains a reality, it is imperative for players in this space to help make this happen.

Interoperability of different blockchains is indeed going to play a major part in hastening adoption the technology and 2020 should be the year when tech organizations should start prioritizing this.