Blockchain — A tired buzz-word with revolutionary potential
Disclaimer: this blog post was put together for informational purposes only based on my review and analysis. This should not be construed as a solicitation, offer, or recommendation to acquire or dispose of any investment, engage in any transaction.
By Nassim Olive, CFA — Partner at Eterna Capital
“We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” — Amara’s law
Imagine a world where you can instantaneously send money to your friend or family at minimal cost wherever they are. A world where you can track the source of each ingredient in your plate. A world where you can vote via your smartphone or where you don’t need to wait weeks before receiving your insurance claims back. This is how blockchain can and will change the way we live and work.
In this short blog, I will provide some color and explanations on what is blockchain, how it works and what I think are its most promising use cases. Before you continue reading, it is essential to keep in mind that blockchain and cryptocurrency are two different concepts.
The argument that blockchain is revolutionary is undeniable but the technology has gone through various stages of the Gartner hype cycle [1]. Since the last peak in December 2017, people have naturally moved to the “disillusionment” phase however on the ground fundamentals are dramatically improving and real development is happening.
Blockchain in a nutshell
Blockchain is essentially a special type, namely distributed, of database. Instead of relying on a central trusted intermediary to authenticate and keep records of transactions, it relies on “cryptography”. This computer science coding method enables the creation of a single copy of records that is shared across a network of computers that constantly verifies and reconciles transactions. Its functionality makes it close to impossible to be tampered with or changed retrospectively.
The first and most famous application of blockchain technology was released in 2009 — Bitcoin. Bitcoin is a cryptocurrency and blockchain is the technology that supports it. A cryptocurrency refers to a digital coin or token that runs on a blockchain.
Bitcoin in a nutshell
Bitcoin is the idea of a mysterious person (or group of people) known as Satoshi Nakamoto. No one knows the identity of Satoshi, but the vision behind Bitcoin was laid out in a whitepaper released late October 2009 called “Bitcoin: A Peer-to-Peer Electronic Cash System”.
In the early days, the concept was ideological — driven by the idea that post the 2008 financial crisis, centralized institutions (e.g. banks) became untrustworthy meaning that they had to be replaced. But instead of replacing the institution, we could find a way to build a self-efficient network where you and I could transact value with no central authority — the Bitcoin blockchain was born.
While the Bitcoin blockchain is working fine, it is not made for companies to build applications and processes on. A number of other companies are building blockchain platforms to help enterprises interested in the technology build processes and solutions on — the likes of Ethereum, Ripple, Hyperledger, R3 were created.
“We have moved from the ideological concept to a much different philosophy.”
From the ideology to the industry
Over the past decade, the space has significantly matured. A large number of professionals have moved out of the traditional finance and technology industries to the blockchain industry with the idea of building on what could be one of the most disruptive technological innovations of the century. The mindset is clear, instead of getting rid of institutional players, we can work alongside them to drive blockchain adoption.
Attending conferences around the world and interacting with various industry participants, we believe that the blockchain ecosystem has dramatically changed over the past two years. We are seeing numerous signs of positive developments across the board: 1) an increased number of institutions looking at the space, 2) the creation of government led task force groups and initiatives to help clarify a regulatory framework and 3) the development of institutional-like custody, derivatives, data and prime brokerage solutions as well as user friendly interfaces to enable retail mainstream adoption.
The Libra project is worth a mention here. Facebook announced a digital currency called Libra that will roll out for use in 2020 and allow the platform’s billions of users across the globe to make financial transactions online. The project is subject to intense scrutiny from governments and regulators. We see these recent developments as a clear indicator that we have moved from an ideology to an industry.
“The bigger the challenge, the bigger the opportunity for growth”
Challenges to overcome are considerable
For any innovation to work, it needs to be adopted at scale and integrated in the context of our current systems. The industry needs to think about solutions to problems rather than prompting stakeholders to use the technology because it is trendy. Over the past two years, we have seen a number of enterprises looking at how to leverage blockchain technology to improve efficiencies across processes. A global survey released by Deloitte [2] earlier this year shows that “a majority of respondents call blockchain a top-5 priority for their companies”. Having said that “only a quarter have already initiated a blockchain deployment”.
Implementing blockchain is very challenging. Not only it requires to reshuffle current operational systems, it needs participants to simultaneously adopt it and outsource some of the governance decisions to decentralized autonomous organizations (DAOs) — assuming they use a true “decentralized” blockchain model. Under this model there is no single entity that determines how the network is run and how data are managed — decisions are consensus driven.
Where blockchain is used in permission-less way, often for cryptocurrencies, regulation can be a major roadblock to mainstream adoption. Some progress has been made on that front with the release of frameworks and guidelines but the global regulatory obstacle is much more challenging this time around — we are dealing with a borderless economy.
Blockchain is generally misunderstood
In general, it is fair to say that blockchain is not yet well understood by a lot of stakeholders even though it has huge potential to replace many legacy systems.
Technically, you can have various forms of blockchains. If you want a truly decentralized network, you have to sacrifice on speed. If you are willing to give-up true decentralization to prioritize speed, the most efficient way to implement it is via a centralized or pre-determined pool of network validators. There is no right or wrong model, it is a question of what do you prioritize. While decentralization is usually an intrinsic good where you can develop a trust-less network with the right incentives, centralization is also a plausible model if you manage to build a network where you can ensure the pre-determined validators will play fairly.
Corporations have a tendency to think that true decentralized permission-less blockchains are fundamentally flawed due to their lack of scalability. The influx of talent and capital into the space over the past few years has allowed several projects to work on solving the famous blockchain “trilemma” — the fundamental difficult trade-off to have a network that is decentralized, scalable and secure all at once.
“We already see adoption in Financial Technologies, and expect most industries to adopt it over the coming years.”
Blockchain can improve financial accessibility
Blockchain has the ability to disrupt financial markets, make the world substantially more inclusive and also improve inefficiencies across industries. Having said that, it is not the cure to all problems and works best in certain structures. The technology has the most impactful potential where data points are being siloed across multiple systems and exchanged between multiple stakeholders — finance is a natural target. From cross-border payments to proxy-voting, blockchain can streamline processes.
Many people have never had to worry about cross-border payments as they don’t send money abroad. But according to the World Bank the remittance market represented close to $700 billion in 2018 [3] and the average cost to send money abroad is close to 7% [3]. These are enormous fees, but not only is it very expensive, it is also slow. Blockchain could provide real time payments at or close to zero-fees.
The concept of tokenization has been one of the most innovative aspects of blockchain. While we could question the value add of having everything tokenized when most financial instruments are already digitized, there are some obvious use cases — real estate, due to its illiquid nature, is a clear one. Over the past decades, large financial institutions have done a great job at digitizing traditional asset classes such as equities, bonds or commodities but the illiquid nature of real estate has been a challenge.
If we are able to migrate real estate assets to a global network and enable the administrative components of it to be done automatically via smart contracts, we could provide greater liquidity, improve investors’ access to this market by allowing fractional ownership and promote global interoperability. This is a very impactful proposition as it makes a usually unreachable asset for the vast majority of investors easily accessible — democratizing the real estate market.
“Adoption of new technologies takes time.”
Conclusion
The blockchain space has significantly evolved since the birth of the most notable example, Bitcoin, in 2009. Even though blockchain and cryptocurrencies are two different concepts, correlation between the two in hype cycles is close to perfect. Hence, it is difficult to ignore the relationship between blockchain hype and Bitcoin price.
Bitcoin has gone through three hype cycles in history with the last peak reached in December 2017. Since then, blockchain has become a tired buzz-word. This is not surprising given where the technology stands in the latest hype cycle, we are 2 to 5 years away before blockchain reaches the long-term “plateau of productivity” [1].
A lot of work remains to be done to overcome some of the technical and more fundamental challenges blockchain faces. But fundamentals have continuously improved and real development is happening. In a world where globalization is the new norm and where physical cash is losing steam, disruption is inevitable!
References
[1] Source: https://www.gartner.com/en/newsroom/press-releases/2019-09-12-gartner-2019-hype-cycle-for-blockchain-business-shows — September 2019
[2] Source: https://www2.deloitte.com/content/dam/Deloitte/se/Documents/risk/DI_2019-global-blockchain-survey.pdf — June 2019
[3] Source: https://www.worldbank.org/en/news/press-release/2019/04/08/record-high-remittances-sent-globally-in-2018 — April 2019
