INDUSTRY INSIGHT

Can blockchain spark a government services revolution?

If you’ve heard anything about the online currency Bitcoin, chances are it was something negative -- a story about hackers holding business files hostage for ransom or the FBI shutting down a shady online illegal narcotics seller. But this perception is limiting. The technology powering Bitcoin -- called the blockchain -- has the potential to bring additional transparency, security and efficiency to existing government services, while opening up exciting new services that were never before possible.

In order to effectively use this technology, government leaders must first understand how blockchains work and why they were created.

Computer scientists seeking to create currency native to the Internet long faced a dilemma: Since it is so easy to copy digital files, how would it be possible to create an online currency which could not be easily forged, copied or counterfeited? This problem, called double spending, proved tricky to overcome.

The initial solution was to empower a trusted intermediary, such as PayPal or Wells Fargo, to maintain user account balances and verify the funds being transferred were not counterfeited or already spent. This solution, however, has its own problems. Payment processors must maintain their users’ personal and financial information, making them attractive targets for hackers. In addition, banks face profit pressures to loan out larger and larger fractions of depositor funds, which makes financial crises and bailouts more likely.

Crypto-currency, such as Bitcoin, solves the double spending problem in a more efficient way. The system is built on a technological innovation called the blockchain, which allows users to verify the legitimacy and validity of fund transfers without trusting a third-party to maintain account balances. A blockchain system requires each new proposed record to reference the entries that precede it, using a software algorithm that ensures any attempts to change data are easily prevented.

The peer-to-peer nature of blockchains makes them open to inspection by all participants in the system; therefore, they also rely on encryption to protect the privacy of user data. In this way, Bitcoin uses a blockchain to securely, yet transparently, track the balance of user accounts, eliminating the need for an intermediary that could be breached or bankrupted.

Because of the complex and rapidly changing nature of the technology, Bitcoin has presented challenges for government regulators and oversight entities. The currency is borderless and nearly anonymous, features that make it a favorite form of payment for online scammers and criminals. But these challenges have not prevented regulators from taking important security steps in overseeing the use of Bitcoin.

The Department of the Treasury’s Financial Crimes Enforcement Network, for example, has stepped in to make sure Bitcoin companies perform due diligence to prevent money laundering and terrorist financing. And in late 2015, the Securities and Exchange Commission approved for the first time the issuance of corporate stock that can be traded on a blockchain rather than through traditional stock exchanges.

Many other federal agencies have weighed in on Bitcoin, including the Commodity Futures Trading Commission, Consumer Financial Protection Bureau, and the Internal Revenue Service. At the state level, the New York Department of Financial Services released regulations subjecting most Bitcoin companies to strict licensing, capitalization, recordkeeping, and reporting requirements.

Although many agencies have considered Bitcoin from the perspective of preventing financial crime and protecting consumers, blockchain technology can be applied in other contexts, enabling the faster, more reliable, more secure, and more transparent delivery of government services to constituents.

For example, the government of Honduras has commissioned a land title registry that uses a blockchain to reliably and transparently record and transfer property ownership. And it is not just international governments who are starting to explore this notary-like function of blockchains. Connecticut’s Department of Economic and Community Development surveyed local technology businesses and stored the responses in a blockchain. American political parties have explored a similar use of the notary function of the blockchain to facilitate electronic voting. In each case, the survey or voting data is encrypted to preserve privacy before recordation into the blockchain. Respondents are then given a password allowing them to verify the accuracy of their information.

In addition to enabling secure public databases, the blockchain also makes possible new government services that were not previously feasible. For example, since Bitcoin transactions are unchangeable and blockchain records of each account and transaction are open to public inspection, a financial reporting or purchasing system based on the blockchain could provide assurances to citizens that their public funds are being spent responsibly. Indeed, during a 2015 campaign, a candidate for mayor of London pledged to run the city’s finances using blockchain technology, allowing the public to instantly see and audit each expenditure as it occurs.

Blockchain-based smart contracts are another futuristic use of the technology. For example, an enterprising locality could offer a blockchain-based municipal bond that automatically accrues and pays interest to its holder on a pre-determined schedule. Indeed, the state legislature in Vermont has already begun considering the use of smart contracts for state business. The blockchain not only makes existing government functions more secure, open and efficient, but it also enables exciting new government services that were previously unimaginable.

Perhaps the most thorough exploration of governmental uses for the blockchain came earlier this year in a report commissioned by the U.S. Postal Service's Office of the Inspector General.  The report analyzes myriad ways blockchains might help the agency achieve efficiencies and cost savings, as well as potential threats to the USPS from this transformational technology. For instance, the agency might create a USPS-branded digital currency, called Postcoin, which could allow the agency to expand its international market and continue providing financial services at a fraction of the cost.

The USPS OIG also suggested blockchain technology may be used to provide and manage a secure digital identity, a persistent challenge at all levels of government. And the Department of Homeland Security recently awarded research grants to study the applicability of the blockchain for secure identity management.

Regulators must be educated about blockchain technology to strike the proper balance between preventing digital financial crime and allowing a new industry to flourish. Beyond their roles as regulators, government leaders should also know of the enormous potential for the technology to increase security and transparency in the delivery of government services. New systems built on the blockchain may also enable new ways of communicating with and meeting the needs of constituents. Indeed, pioneering cities, states, and even federal agencies are now beginning to explore how the blockchain can help government provide more efficient, transparent and secure services in the digital age. By embracing the benefits of blockchain, government agencies could jumpstart a new era of efficiency, transparency, and innovation in the public sector.

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