Blockchain can be an incredibly hard topic to cover or it can be really easy. Blockchain is such a new and, in most cases, untried technology that it can be easy to make some bold metaphysical statements and sound pretty smart. Instead, the goal of this white paper is to put a critical lens to the topic of blockchain and try to understand a little bit about what makes it so interesting and why it may be a true game changer across a wide variety of industries and businesses.
Blockchain represents a seismic shift in how we look at the means to transfer value so it’s understandable to not fully understand blockchain from the get-go. However, there is a virtual tsunami of new blockchain backed cryptocurrencies and blockchain is being used in industries as varied as healthcare and real estate. There’s no reason to think that this technological genie is going to be put back in the bottle; blockchain is already changing everything.
So, what is blockchain? Well, as Socrates said “the beginning of wisdom is the definition of terms” so let’s spend some time to get straight on what we’re talking about. We’ll take a few different passes at this, starting with a definition and moving on to a few analogies, in an attempt to find a description or definition that resonates with you.
The first thing that’s important to know is that blockchain is a technology, specifically a software. And this technology leverages distributed networks such as the internet and it takes advantage of the advanced mathematics of cryptography to ensure that transactions on the blockchain can be trusted. This is the central premise of blockchain: ensuring trust. Because there isn’t one central authority in blockchain – something like the Fed for US dollars or The Recorder of Deeds for a real estate transaction – trust is built into the mechanism of the blockchain.
In a blockchain, each node of the network has a copy of the blockchain (you may have heard this referred to as a distributed ledger) and changes to the blockchain are reached by consensus. Each of these nodes, which you can think of nodes as a computer or a server, has to agree before a new transaction can be added to the chain. It is the consensus mechanism that acts as the method for delivering trust in the blockchain. Once a transaction is accepted, it is attached to the rest of the blockchain (this is when it is turned into a block). It references the block that came before it and is now part of the record that is held at each node of the network.
Now, because every node has a copy of the ledger and every block has a reference to the one that came before it, it is extremely difficult to hack or corrupt a blockchain. You not only have to affect a seamless change to the blockchain itself, but you also have to get the other nodes to concur on the change. You have to do so in a race against the clock because new blocks are being created as you try to carry out your hack. The interplay of cryptography, the distributed network, the requirements for consensus, and time all conspire to thwart a would be hacker and, on the other hand, ensure trust in the blockchain.
Naturally, there is a great deal of skepticism about blockchain. There have been stories in the news about cryptocurrencies being stolen and also about some very smart people who are skeptical about blockchain. Here’s a couple of points to consider: First, the thefts that you’ve heard about are largely the result of lax enforcement of simple cybersecurity best practices, things like two-factor authentication. Second, you should be skeptical because just like any new technology it’s easy to get swayed by the “wow” factor and a naive belief that this new technology will solve all of your problems. We all know that this is simply not the case and it is wise to take your time, keep your guard up, and take small, incremental steps in adding any new technology.
How Does Blockchain Work
This simplified diagram visually explains how a blockchain transaction works. We start with a transaction; party A has agreed to exchange something with party B. At this point, a request is sent to the network and the nodes on the network agree to accept it. Now, it’s not part of the blockchain at this point because it has to be first converted into a block. The point here is that the transaction can be rejected at this point for a number of reasons. However, if it is accepted, then one of the nodes on the network employs cryptography to validate the transaction and it bundles a number of transactions together to make a new block. With that work done, this block is attached to the end of the blockchain and at that point, the transaction is complete and there is a permanent and unalterable record of it as part of the blockchain.
A Word About Bitcoin
At this point, let’s take a slight detour and look at bitcoin. This is what most people hear about in the news and bitcoin and blockchain are sometimes used interchangeably, which is not accurate. Bitcoin was invented in 2008 by a person or persons named Satoshi Nakamoto and the technology behind it is blockchain. In effect, bitcoin was the first blockchain but it is not the only blockchain. It’s a little bit like saying that a vintage Volkswagen is a car but not all cars are Volkswagens. This is the same for bitcoin and blockchain: bitcoin uses a blockchain but not all blockchains are bitcoin.
To take the analogy further, a Volkswagen Rabbit is a means of transportation but it’s not the only form of getting around, the Hyperloop is also a form of transportation. The point here is that bitcoin was originally developed as a cryptocurrency but not all blockchains are cryptocurrencies. Blockchain can be used as a means to transfer value and there are more ways to do that than just currency. So don’t get stuck with the idea that blockchain is just money: it can be used in a virtually limitless number of ways to transfer information and value between parties.
What People Are Saying About Blockchain
One very helpful article by Marco Iansiti and Karim Lakhimi was published in the Harvard Business Review in early 2017. In the article, the authors postulate a model for blockchain adoption and their central premise is that blockchain is at it’s root a transformational technology. According to Iansiti and Lakhimi, “Blockchain is a foundational technology: It has the potential to create new foundations for our economic and social systems.” It is this fundamental nature of blockchain that can make it so hard to grasp and comprehend.
Analogies can help to provide tangible examples and help refine our understanding of blockchain. The first analogy comes from Bettina Warburg and she compares blockchain to Wikipedia. Wikipedia has become the go-to source to look up information. With Wikipedia we can see the source of everything in the definition and it’s a composite set of information that is constantly changing, and these are changes that we can track over time. Wikipedia is at its core a data infrastructure. Blockchain has all of these same attributes albeit with a technical root in determining truth, not the human, crowd-sourced method that Wikipedia uses. Both Wikipedia and blockchain are byproducts of the internet, however, and it’s the network that is critical to their success.
To expand on that, Don Tapscott and others have described blockchain as a second era of the internet. The first gave us things like email and Wikipedia – this is a network of information. Blockchain goes in a different direction as it uses the network in relation to value, not just information. So you have networked money like bitcoin and many others, but you can also use the blockchain technology for personal data, like health and credit records, as well as for real estate, intellectual property like music or art, and many, many other applications. Blockchain gives us the means to use the powerful network that we know as the internet to now deal in value. This is a simple, yet profound idea.
If you’re struggling about the “why” of blockchain (why is it even necessary or helpful), consider the perspective of old versus new. We have created a fast and efficient digital world but along the way there are many analog processes that have become outmoded or obsolete. In the earlier referenced HBR article, the authors draw an analogy to an F1 race car that is stuck in rush hour traffic. The race car is the finest and fastest technology but it can’t be utilized to its potential because the track it’s running on doesn’t fit its capabilities. In the same way, the contracts that we currently use, the legal forms that we require, and all manner of the way that we conduct transactions are rooted in the past, while there is a new technology in blockchain that can go faster and do more than our old forms and practices. Looked at this way, blockchain is going to be a catalyst for change in the way that we do things.
Real World Example
How might that happen? What are areas that are currently seeing a great deal of blockchain activity and what can they tell us about the present and future for blockchain? Let’s look at three areas specifically: remittances, land titles, and financial products.
In 2015, New York Times ran an article that described how freelance artists like graphic designers as well as computer programmers in Argentina were utilizing cryptocurrencies to get paid. Argentina was in bad economic shape at the time, with high inflation and a declining peso, and it could take up to four weeks for payments from the U.S. to Argentina to work their way through the banking system. In that amount of time, those on the receiving end of the payment could lose significant value as the exchange rate of the peso fell from the time of the contract completion to when they finally received their money. These freelancers were among the first to start to use cryptocurrencies. With crypto, they could receive their payment in a matter of hours rather than weeks and then immediately convert from cryptocurrency into pesos. Much less risk, much quicker payments.
Globally, the remittance market is pretty big as well as slow and expensive. The World Bank estimates that the global remittance market in 2016 was $575 billion. The average fee for having a bank or other financial institution handle the transaction is 7.3%, meaning the total cost of fees for those remittances was over $42 billion last year. Clearly, the market is ripe for disruption because it has the three salient features of being big, inefficient, and overly expensive at the same time.
Another segment with massive inefficiency is real estate, specifically land titles. The World Bank estimates that 70% of all the land and property in the world does not have a clear or secure title. In other words, there is uncertainty when it comes to these assets and this uncertainty raises costs. Some are hidden costs like the fact that a lender is less likely to make a loan based upon title to property that is uncertain, meaning that the value of the asset is trapped due to uncertainty. Another cost is time because uncertainty means that it will take more time to process and approve any transaction that is approved. The less clear and certain a transaction is, the more time it is going to take to complete. And then there’s the problem of redundancy and waste. The higher the level of uncertainty the more paper and process will be required to mitigate risk.
For all of these reasons, adding blockchain to land registry and title makes sense. Even in the United States, where we have a pretty solid system for land registration, the addition of blockchain could speed the process by eliminating steps and lower the cost from items like title insurance and lawyers fees. For all of these reasons, then, it’s not surprising that land registry and title has been an area of keen interest when it comes to blockchain.
The third example deals with investing, specifically private equity, and in particular the case study of Northern Trust. If you are unfamiliar with private equity, it is pretty much what the names says it is: an equity investment that is not publicly listed and traded like common stock but rather held in private hands. While there are regulatory rules about private equity, these rules are much less complicated and prescriptive than they are for publicly listed securities. The flip side of this is that there is much less information available about private equity and it takes much, much longer to complete a private equity transaction due in large part to uncertainty.
These factors make it a good candidate for blockchain adoption – greater transparency and certainty can help to speed the process and lower cost at the same time. And this is what Northern Trust set out to do as they introduced the first private equity offering with blockchain in early 2017. Importantly, they did so with one fund, one fund manager, and one regulator to a limited number of customers. There was no effort to reinvent the wheel, only to enhance it and to do so in a way where small steps rather than giant leaps were the focus.
Importantly, Northern Trust worked closely with their regulator throughout the process and, in fact, blockchain delivers greater information flow and, therefore, certainty to regulators because they are set up as a node on the network. With a traditional product, a regulator would have to wait for transactions to occur and then weeks or months later they could see a record of transactions. With blockchain, a regulator can be part of the flow and be granted access to immediately and without delay capture activity. Once again, uncertainty is reduced and in this case that ultimately might mean greater flexibility when dealing with regulators. By all accounts, the experiment has paid off and Northern Trust announced in May 2017 that they were going to a beta version that would include more customers.
At the end of the day, the point is that blockchain technology works in real life products and its adoption is spreading.
We hope we’ve made the case that blockchain is real and that there is some level of inevitability for its adoption. Blockchain is a logical step in the evolution of the connected world that we have created and it’s an evolutionary step of technology from the internet of information to the internet of value.
We used examples that were both big and understandable today but there are many, many more examples out there where blockchain is on the rise. Healthcare is very big, both from a research and patient standpoint, as are logistics, manufacturing, intellectual property, and more. It’s very likely that blockchain will have impacts that haven’t been predicted yet, just as the inventors and early adopters of the internet didn’t foresee Google, Uber, and Spotify. It is still very early days – blockchain will be only ten years old next year – but change is happening fast. And the change is very real.
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