The word "Blockchain" has become very popular amongst students when Michel started teachning at EDHEC. Many students had dabbled in cryptocurrencies and became vocal promoters of cryptocurrencies, without fully understanding the business models or the technology. In a course developed to demonstrate the technology , its mechanism, its potential, and more, using online simulations to explain concepts such as hash, block, blockchain, private and public keys, the students were challenged with two questions.
- How do you create value? Are you bringing a solution to a problem people are ready to pay for?
- Is a blockchain based technology the best approach to solve that problem?
Recent events about the demise of a major player in the crypto-economy made me revisit a viewpoint written a few years ago.
A simple definition: What is the blockchain after all?
- It is a distributed database. Unlike traditional databases hosted on a server or a PC, with a single active copy, the blockchain exists in identical versions at multiple locations in a network. Those locations are independent of each other
- It maintains a list of records that cannot be changed. It can grow, but cannot change anywhere but after its last “block” by appending a new block.
- It relies on a consensus mechanism where independent parties validate the integrity of the entire chain, making sure a malicious attempt at reversing or modifying one record does not succeed.
So with those three characteristics, blockchain technology allows untrusting entities to agree on the validity of a common digital trail of transactions, a shared history. It can be used to realize financial transactions and much more.
How to determine “Value” in blockchain applications?
The best know application of blockchain technologies is the “Bitcoin”. Bitcoins store value, but they also have value as you can exchange them for Euros or Dollars. But where is this value coming from? Basically, it is offer and demand. The bitcoin allows people to realize transactions that they cannot do as easily with other means, faster, more securely. Although there is no gold bullion and central bank reserves behind the bitcoin, nowadays, major currencies are not by a long shot fully backed by physical assets in central banks. Rather it is the trust and its ability to act as a facilitator of trade that helps determine the value of currencies. The Bitcoin, or other cryptocurrencies can ease transactions in countries with broken economies, but also for those transactions that want to remain under the radar of authorities. Some have analyzed that almost half of the funds exchanged in Bitcoins are illegal transactions (Foley, Karlsen, & Putniņš, 2018). If all were in Bitcoins, it would more than double. On the other hand, as authorities begin to understand how to unravel bitcoin addresses, the illegal trade moves to other currencies with more anonymity.
Beyond that exchange value that can become highly speculative, as it is primarily driven by demand, blockchain applications deliver improvements in terms of speed, transaction cost, and trust that can lead to business applications generating profits. Below are examples of situations in which blockchain can create value in the way it is used, rather than having intrinsic value. Those applications revolve around the improvement of operations and processes. Lets look at some examples.
- Here, in Europe, we tend to forget that a transfer of funds from a Chinese entity to a South African client is significantly more complex and involves more intermediaries than between a Belgian supplier and its Spanish client. But the majority of exchanges are involving multiple institutions and multiple currencies. The financial industry offers another illustration of the potential for blockchain enabled applications. Banks and financial institutions are banding in alliances around a different kind of cryptocurrencies, those that aim at speeding and facilitating transfers between unrelated institutions.
- Supply chains that cross multiple countries with multiple entities involved in each country, such as manufacturers, customs, agents, certifying institutions, shippers, distributors, rely on a thick paper trail slow and complex to generate, transmit and validate. The transfer of value from the consumer using the product to the producer via multiple intermediaries is slow. Frauds can divert or alter goods flowing downstream or funds flowing upstream. If a blockchain enabled service allows to improve this process, value can be created as middlemen and intermediaries do not need to be hired, and producers receive their money faster. Solutions like Tradelens or IBM Food Trust have demonstrated value creation with blockchain technologies
- Other document heavy operations like in health care, where physicials, hospitals, private insurances, social security systems and patients all contribute information and funds can benefit from blockchain enabled applications to facilitate the validation and tracking of all relevant information, making elements accessible to those who have the right to see them, like physician, while keeping them shielded from insurances or employers. Likewise, blockchain technologies can facilitate the registration of important documents proving ownership of a house, for instance.
- Smart contracts are another illustration of blockchain applications that can deliver value by facilitating transactions. They are an additional feature that can be appended to a blockchain, and trigger events automatically, using information that is independently provided.
Those are examples of applications where blockchain enabled services provide a clear and legitimate business proposition. There is a clear demonstration of a benefit for the parties using those services in terms of speed, trust, or ease.
Unfortunately, the fundamentals of value creation have been discounted by some promoters of the most visible blockchain technologies, the cryptocurrencies. There is a belief that cryptocurrencies will increase in value without asking what service they deliver, with a "sky is the limit" illusion. Then comes the bubble.