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What’s the deal with Blockchain?

[10 minute read]

“I’ve come up with a set of rules that describe our reactions to technologies:

  1. Anything that is in the world when you're born is normal and ordinary and is just a natural part of the way the world works.
  2. Anything that's invented between when you're 15 and 35 is new and exciting and revolutionary and you can probably get a career in it.
  3. Anything invented after you're 35 is against the natural order of things.”

- Douglas Adams

Speaking as someone who’s been in stage #3 for a long time now, I’ve been somewhat befuddled by speed of the emergence in trends like Blockchain, Non-Fungible Tokens (NFTs), and now Decentralized Autonomous Organizations (DAOs).

What I do understand is that the big theme in technology right now is a tsunami of decentralization. The infrastructure underlying a great deal of this is blockchain. There have been half a million new publications on blockchain in the past two years alone. And I’ve successfully avoided reading almost all of them. So this very quick piece will be aimed at my own ashamed and uninformed level.

Having now dug a little deeper, the blockchain debate is almost religious in fervor. Some advocates believe that half of the world’s assets can be “tokenized” and put on the blockchain. While others argue it’s mostly hype: a glorified database technology that’s a less scalable version of Google (spread) Sheets. This makes it tough to do our job of trying to avoid the infinitely crowded opinion space, and focus on the realities on the ground.

Stepping back for a second- what is blockchain? A blockchain is a database that is shared across a network of computers. Once a record has been added to the chain, it is immutable. To ensure all the copies of the database are the same, the network makes constant checks. Fabricio Santos is famous for the “glass box” metaphor:

“Imagine a huge vault from a bank. The vault is filled with rows of unlabeled deposit boxes. However, each deposit box has a glass facade, allowing everyone to visualize the contents of the deposit box, but not access it. When a person opens a new deposit box, it receives a key that is unique to that box. Making a copy of the key does not duplicate the contents of the box. And in the same way, even though you have the key, the box is not technically yours. You only have the ability to access what’s inside of it.”

To be clear, in this example, the digital asset, like an NFT or cryptocurrency, is what’s inside the box, the box infrastructure itself is blockchain. It’s primarily a business model innovation, not a speculative asset.

To its advocates, the core benefits of blockchain are decentralization, cryptographic security, transparency, and immutability. On an “Invest Like The Best” podcast this week, Andreesen Horowitz General Partner Chris Dixon ran through the potential applications and labels blockchain as a “new capability of the internet itself.” He compares it to a new public infrastructure for the web.

Up until this point, blockchain had struck me more as a solution looking for a problem. A podcast I circulated a few weeks ago from McKinsey had concluded that the likely path to adoption was top-down. You either needed an authoritarian government or a dominant industry player. That’s…. somewhat ironic for a decentralizing technology? The third option is obviously compelling business cases, and that is what now seems to be emerging. CB Insights projects blockchain spending to increase fourfold from $4.3 billion in 2020 to $16 billion in 2023.

But what’s happening right now? Gartner’s “3 Blockbuster Blockchain Trends in 2021” identifies supply chain and Decentralized Finance (De-Fi) as the two key growth drivers.

Supply chain makes a great deal of obvious sense. As the world simultaneously deglobalizes and complexifies, sleeker supply chain management is going to become essential. Gartner also makes the shrewd observation that demands for more responsible investing are going to increase pressures on suppliers to show ethically defensible sourcing practices. Daimler is now using blockchain to track carbon emissions across its entire supply chain. There are also practical cost-saving applications: Wal-Mart now has a lot of their food suppliers on the blockchain. They can now determine the provenance of a single mango in 2 seconds rather than 7 days. This is a huge advantage in areas like leafy greens, where food-borne outbreaks can cost them tens of millions in blanket recalls.

Blockchain is especially useful for verifying and transferring. Hence, finance has a very direct potential benefit. Capital markets post-trade settlement and regulatory reporting could be significantly streamlined. Ninety percent of major European and North American banks are experimenting and investing in blockchain (Source: Deutsche Bank Research). Direct lending can also be potentially improved with rapid approval turnaround.

But, as Matt Levine, who I believe is finance's best commentator, regularly points out, “most of what actually happens… is about rediscovering financial history and re-creating the traditional financial system from scratch.” When you accidentally lose access to your $200 million in cryptocurrency, an intermediary suddenly becomes useful again.

Consistent with McKinsey’s conclusion, governments can significantly benefit from frictionless verification. Blockchain can facilitate digital containers for proofs like birth certificates, personal identification, or property ownership. Moreover, a digital central bank currency could be a paradigm-shifting event for the capital markets. One of the better pieces I’ve read was by Niall Ferguson a couple of weeks ago on the whole ecosystem (“Don’t Let China Mint the Money of the Future” in Bloomberg). He explains the link between the metaverse (a recent Attention Span topic), blockchain, De-Fi, NFTs, and digital central bank currencies.

China has been working on their own digital currency since 2014. In the U.S., Jerome Powell discussed the digital dollar in February of this year. The strategy is interesting. According to Sahil Mahtani of the South African investment manager Ninety One, the ultimate goal of Chinese policy is “to create a parallel payments network — one beyond American oversight — thereby crippling U.S. sanctions policy.” This also hints at the big latent risk to blockchain technology: regulation.

For broader business implementation at scale, we’re looking 3-5 years out, according to McKinsey’s recent “The Recovery Will Be Digital” report. Gartner agrees it’s going to be a tricky path:

“Enterprise adoption of blockchain technology is difficult today. There are too many decisions an enterprise has to make – they have to pick a blockchain platform, a smart contract development environment, tools to develop decentralized applications, figure out how they will interoperate across blockchain platforms, integrate with legacy systems, and communicate with other blockchain network participants when data standards are generally scarce. These are just some of the thorny decisions an enterprise must make around still-immature blockchain technology, where skills are scarce, rewards are not entirely clear, and governance by taskforce or consortia is at best difficult and at worst a failure.”

Sounds like a lucrative opportunity for blockchain consultants. But what’s beyond doubt at present is that the emergence of speculative assets like NFTs and initiatives like DAOs are getting the mainstream more comfortable with the underlying blockchain technology. The wider the use-cases spread and the longer the system goes without a meaningful hack, the more companies will be open to experimenting with broader adoption.

This has two second-derivative impacts. Dixon believes that NFTs spreading to hundreds of millions of people will help build out the infrastructure layer of blockchain. It’s simply more comprehensible than extremely complex De-Fi. This leads to the most interesting and utopian long-term promise of blockchain- the democratization of creative endeavor. Dixon:

“I think this idea that this is a new way to finance creative activity. By the way, I define that very broadly. I mean, there's the traditional creative things of writing and art, visual art and music, but there's also writing code, open source code.”

Near-term, as with all disruptive technologies, it might make sense to look at potential losers rather than winners. “The right call from the invention of the internal combustion engine wasn’t to go long cars, it was to short horses.” Blockchain seems to impact potentially redundant middlemen the most; for example, lawyers and administration. McKinsey’s estimate is that 70% of the short-term value is from cost reduction. Hence, early stage benefits will accrue to individual management teams looking for more frictionless ways to cut costs. The longer term view is that Internet 2.0 platform companies will lose out to decentralized 3.0 companies; for example, a ride-hailing app that allows for more direct transactions between driver and passenger.

As you’ll be able to tell, this is intended to be the start of a discussion rather than a definitive guide, so if you’ve seen any superb content or have a view, please share it with us. Thanks to everyone who gave up their time to let me ask stupid questions.

Tom

Some external sources I found useful:

  • Podcast: This week “Invest Like The Best” did a timely guide to the potential of Blockchain (1 hour 12 minutes).
  • “The Recovery Will Be Digital”- McKinsey
  • “3 Blockbuster Blockchain Trends in 2021”- Gartner
  • “HFS Top 10 Enterprise Blockchain Services 2020”
  • “Don’t Let China Mint the Money of the Future” – Niall Ferguson in Bloomberg

Tom Morgan
Director of Communications and Content
The Knall/Cohen/Pence Group

Work (317) 571-4525

Cell (917) 656-2742

thekcpgroup.com

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