The central bank of the Netherlands is preparing an ambitious experiment aimed at discerning if an entire financial market can be built on a blockchain.
While many so-called smart contract applications of blockchains can be replicated using existing technology, the man in charge of a series of experiments conducted by De Nederlandsche Bank says the distributed nature of blockchains could lead to entirely re-imagined financial market infrastructures (FMIs), ones that are much more difficult to hack.
Like the bitcoin network itself, the experiment envisions how an FMI’s internal operations could be distributed among participating nodes. To game the system – and break the financial market infrastructure — an attacker would need to gain more than half the computing power running the nodes.
News of the experiment, scheduled to begin later this year, comes as financial market infrastructures are increasingly being targeted by hackers. Earlier this month, the chairman of the Bank for International Settlements (BIS) went so far as to call for immediate action on potential solutions to the issue.
Now in a new interview, De Nederlandsche Bank’s head of market infrastructure, Ron Berndsen, explained why he believes blockchain could be the key to preventing more attacks.
Berndsen told CoinDesk:
“If hackers were to go through the trouble of taking down two or three data centers they would take down the financial markets infrastructure. With blockchain, you could distribute the nodes and you might not even know where they are.”
To learn if an FMI can be distributed via a blockchain, Berndsen is once again tapping into the team he assembled for earlier experiments at the central bank.
Berndsen said he recruited the team of seven around coffee machines and via email invitations sent to bitcoin enthusiasts he identified within the bank.
The academic and banker is rare in the world of global financial bankers in that he began running a full node on the bitcoin network and mining the digital currency in the early part of 2013. Though he said he never earned a mining reward for his efforts, he purchased bitcoin and other digital currencies to learn the advantages and disadvantages of each.
Lessons for central banks
As a result of that familiarity, Berndsen has been able to scale up his experiments.
Announced last month, the central bank began using the open-source bitcoin software to recreate conditions at the network’s inception in 2009 in an effort to model what the system might look like in 2140, when the last bitcoin is mined.
“As an academic it was very obvious to recreate the extreme points,” said Berndsen, who has a doctorate in economics and is a professor of FMIs and systemic risk at Tilburg University in the Netherlands. However, he said he now believes the test to be among the more unique globally.
“I thought every central bank would have done this,” he said, adding:
“I’m on many central bank committees and I expected they were all doing this, but so far they weren’t.”
Among the lessons he learned from the experiments, is that the bank was able to mine what the team called DNBcoins at a much faster rate by starting with an initial block reward of 1bn DNBcoins and halving the reward every two minutes.
Of note, he said his team observed that even if what they call the “max money parameter” was set to 21 million coins — as is the case with bitcoin — they were able to mine 10 billion coins.
They also “proved” that a network could continue to run on fees alone after the bitcoin reward is dispersed, he said.
The third experiment, Berndsen said, will now be aimed in the area of financial markets infrastructure.
As defined by the Bank for International Settlements in a 2012 report, an FMI is a “multilateral system among participating institutions, including the operator of the system, used for the purposes of clearing, settling or recording payments, securities, derivatives, or other financial transactions.”
In Berndsen’s speech announcing the results of his first two experiments, he listed FMIs as one of three crucial components of “the overarching goal of financial stability” that his bank aims to provide.
But this year has proven a turning point in the history of FMIs, which have become increasingly alluring targets for sophisticated international attacks.
In March, Bloomberg reported that hackers linked to the Iranian government had attacked about four dozen US financial institutions, including the New York Stock Exchange and Nasdaq.
A month after the report, security expert Eugen Kapersky predicted an increase in financial market threats following a separate attack against Bangladesh’s central bank by hackers who moved the Russian ruble’s exchange rate, according to another Bloomberg report.
The threats against FMIs has been so pervasive that earlier this month the chairman of the BIS Benoit Coeure published “Guidance on cyber resilience for financial market infrastructures.”
In the report Coeure wrote:
“FMIs should immediately take necessary steps in concert with relevant stakeholders to improve their cyber resilience, taking into account this guidance. FMIs should also, within 12 months of the publication of this guidance, have developed concrete plans to improve their capabilities.”
Preparing for the big day
Holland’s central bank has been taking an increasingly public position in its efforts to lead other central banks to consider blockchain applications for a wide-range of possible solutions, now including financial market infrastructures.
In addition to speaking about their bitcoin blockchain experiments at last month’s Dutch Blockchain Conference, the bank last week announced its plans to open a blockchain campus by early September of this year.
Berndsen said it will take years before the full potential of blockchain becomes clear, and that his bank is working to help accelerate that learning curve.
In preparation for the FMI experiment, Berndsen told CoinDesk De Nederlandsche Bank is currently “engaged” with other parties in the industry and other central banks to see if they want to join the experiment as partners.
“We have the idea that this next prototype might require more coding, more thinking and we might need more people.”