A potentially fatal flaw in blockchain
As the Covid-19 panic gripped markets around the world, stock exchanges resorted to the good old-fashioned circuit breakers to stop trading when markets dropped too much too fast. After Black Monday 1987 when markets were allowed to drop more than 20% in one day, everybody agreed that it might be a good idea to protect investors from their own fears. Hence, when a market panic leads to steep losses, trading is suspended so that algorithmic trading programs can be stopped and investors can take a breath, count to ten and calm the f… down. In the week between 9 March 2020 and 16 March 2020, circuit breakers were activated in the US stock market four times and several times more in futures markets.
And that is a good thing. In more extreme cases, a panic can only be stopped by shutting the stock market altogether for several days as has happened several times in the past, most notably after the beginning of both World Wars (not always in the US but in different countries around the globe) and after 9/11 in the United States.
And here is what makes me think that we might have overlooked something in our enthusiasm for cryptocurrencies and blockchain technology. Yes, blockchain technology is incredibly safe because it is constructed to be highly transparent and can only be read by the users with the appropriate private keys. Furthermore, every transaction recorded in the blockchain must be independently verified and once added to the blockchain, it cannot be changed anymore. This provides a virtual guarantee that information about past transactions cannot be changed and users of blockchain technology are protected against fraud or falsification of information.
Another benefit of blockchain technology is that it is decentralized. In a traditional server structure, a hacker can break into the central server and then has access to all the data stored on it. Shutting down the server cuts of all the computers that rely on it. The advantage of blockchain technology is that it is stored independently on the computer of each user. There is no central server that can be hacked. If an individual computer in the network is hacked and shut down or data on it manipulated, the other computers continue to work as if nothing happened. Transactions will be executed without interruption and the hacked computer will simply be ignored.
And now imagine that we would run our stock trades on blockchain technology. If panic strikes in the market, there would be no way to stop trading. If you try to shut down the New York Stock Exchanges computers, nobody would care, because trading would continue uninterrupted on all the other computers in the network. Blockchain is designed in such a way that it will continue forever. You cannot shut it down unless you shut down every computer in the network.
Can you imagine what such a system would have done to stock markets during the Covid-19 panic?
If your imagination fails you, let me tell you a little story about Ethereum, one of the most popular and widespread cryptocurrencies in the world and the technology most commonly used in cryptocurrency applications. In January 2019, a hacker used a software flaw in the Ethereum network to gain control of 51% of the computing power in the network. Ironically, the hacker used a software flaw that was introduced by rolling out a rushed safety update on the Ethereum network that – obviously – wasn’t as safe as the programmers thought. Once the hacker gained access to 51% of the computing power in the Ethereum network, he could manipulate the Ethereum blockchain and verify these changes. Verification if a blockchain is authentic is usually done in a democratic way. If 51% or more of users agree that a blockchain is authentic, it is considered authentic. Hence, the safety update backfired and people quickly lost their Ethereum.
There was no way to stop this theft from happening in clear sight of everyone. The only way to beat the hacker was a bunch of good guys imitating the hack and siphoning off Ethereum into their wallets faster than the hackers could steal the money. Once the hacker lost control of 51% of the network, the original owners would get their Ethereum back. It was a massive effort to stop one hacker and in the end, c. $50 million Dollars were stolen anyway.
I am not sure if I want to trust vital data to a system that cannot be stopped when things go wrong. And I am not sure I want to trust my money to such a system either.