BLOCKCHAIN – A potential Disruptive Innovation


INTRODUCTION

Widely known as the technology underpinning the digital currency bitcoin, blockchain has acquired a new identity in the enterprise. Today, more than 40 top financial institutions and a growing number of companies across industries are experimenting with distributed ledger technology as a trusted way to track the ownership of assets without the need for a central authority, which could speed up transactions and cut costs while lowering the chance of fraud. Blockchain remains in the experimental phase inside many large firms, but the ecosystem has grown rapidly to include eager startups and major technology vendors.

WHAT IS BLOCKCHAIN?

Blockchain is a trusted, distributed ledger with shared business processes.

Blockchain is so called because Bitcoin transactions are stored as ‘blocks’. When a Bitcoin is created or changes hands, a new transaction record gets created comprising blocks of data about transaction request, authorization, execution, sender and receiver. All blocks are linked via an encrypted algorithm creating a chain and, hence, the name Blockchain.

It’s distributed because instead of a central database, records are distributed across all participating network member computers. Entire network collectively creates, approves the transactions and maintains the records. Thus, encryption and decentralisation are the heart and soul of Blockchain technology.

WHAT IS UNIQUE ABOUT BLOCKCHAIN TECHNOLOGY?

Unalterable encryption of records in a transparent distributed ledger is the unique value proposition of Blockchain technology. Each transaction block is encrypted by creating a unique ID for the buyer and the seller and adding those IDs to the block. Each consecutive new block in the transaction network is linked to the previous block by hashing part of the previous block. The ledger grows as new blocks are created in a linear and chronological order, each linked to the other via encryption process. Entire transaction history is digitally recorded in these encrypted blocks.

Data in each block is continuously validated by all network members and a transaction is approved only upon mutual consensus of all. Once a transaction is committed to the ledger it becomes unalterable and effectively tamperproof since it requires the consent of each participating computer in the network. The mathematical difficulty of tampering the unique IDs encrypted into each block in the chain makes Blockchain immune to fraud.

By entrusting validation responsibility to entire network, distributed ledger completely eliminates the role of a third party central bank or a clearing house which is crucial in traditional payment structure. Since there’s no need for a third party validation, there’s no T+n process (trading day + number of days needed to complete the transfer of ownership in a traditional trading system) and asset ownership can move immediately after the transaction is approved by Blockchain protocol.

While records are open to entire network, transacting parties are anonymous and usually pseudonyms. Transactions records are created and maintained without personal information of transacting parties. That’s why it is called ‘trustless’ system.

WHAT IS THE VALUE PROPOSITION CREATED BY BLOCKCHAIN TECHNOLOGY?

The five distinguished differentiators of Blockchain technology are:

  • Decentralized or distributed bookkeeping
  • Total digitization of records
  • Absence of intermediary
  • Untamperable records
  • Near real-time transfer

The advantages to the business from these differentiators are as follows:

  1. Saves Time: Transactions using Blockchain are instanteneous. Traditionally, settlements for stocks, bonds, etc. are possible to complete only in T+2 or T+3 duration. With Blockchain, this is reduced to T+0. Faster settlement means Banks don’t need to hold huge cash reserves or other collaterals against settlement risks. Immediate settlement cuts down the impact of inflation and currency fluctuation risks. Loans can be underwrutten the same day instead of waiting for weeks.
  2. Removes Costs: Traditionally, business houses have a lot of spend towards internal and external audits. These costs are vastly reduced or totally eliminated by use of Blockchain. In addition, overhead costs of transactions and hefty cost of intermediaries are eliminated. In addition, using Blockchain, there is no scope for redundancy or reconciliation problems since Blockchain processes each transaction only once. An immutable ledger ensures stricter auditing and regulatory compliance.
  3. Reduces Risks: Traditionally, business are prone to fraud due to compromise of data. Each and every business house has set up mechanisms for Data Security. In addition, regular operations create errors which are costly to identify and even more costly to rectify. Using Blockchain, creates Tamper-Proof transactions without any risk of fraud and cyberattacks. Unaltered digital records simplify KYC and identity theft management.
  4. Increases Trust: Using Blockchain, every transaction is effected only after approval of all the parties as per the defined shared business process. The Smart Contracts, based on which business processes are executed, are built into the system and cannot be altered unless all the parties consent to the same. Unbanked population can avail financial service like bank account and loans by establishing their credentials on the strength of being part of the distributed ledger.

WHAT IS THE NATURE OF THE INNOVATION IN BLOCKCHAIN?

Blockchain is said to have the potential to revolutionize not just financial supply chain, but to disrupt whole lot of industries across the globe leading to rewriting of fundamentals of macro economy.

However, Blockchain will not replace the traditional structure any time soon due to numerous valid reasons.

  • Global blockchain to become a reality, all or majority must join the same network which will not happen overnight
  • Apprehension due to lack of regulation
  • Since blockchain records are transparent to the network, financial organizations, or even customers, will not be comfortable opening the books to everybody
  • Banks, underwrites and brokerages earn sizeable fees as intermediaries. They not only have to sacrifice this income but also must invest in new technology
  • Bitcoin got hit by scandals such as Silk Road (online illegal drug market) and Mt. Gox (Tokyo-based Bitcoin trading exchanging closed and filed for bankruptcy due to missing assets). These incidents highlighted the importance of trusted position held by financial organizations as intermediaries validating the authenticity of monetary transactions.

 

Below I benchmark blockchain against some of the characteristics of disruptive innovation that the world has been experiencing to reassure if blockchain would qualify to be one.

The assumptions are as follows:

  1. We stay focused on the blockchain technology for business and are not referring to crypto currencies or related regulatory aspects.
  2. We are not comparing different blockchain technologies for its features of distributed ledger, immutability, reliability, performance, process digitalization etc.

I have selected two aspects of definition and three aspects of practicality with respect to disruptive innovation that we will benchmark blockchain against.

  1. Creation of new markets
  2. Acceptability
  3. Exponential improvements
  4. Convergence
  5. New business models

Creation of new markets: Disruptive innovation refers to a technology or business model innovation that result in large scale change in the way businesses run leading to creation of newer markets. To refer a few, cellphones has long replaced fixed line phones and there is a model for social users, business users and photography enthusiasts alike., AirBnB has created short term accommodation for all type of travelers both with affordable and luxury options. When new markets are created, the incumbent market either gets upgraded or become extinct. The Celeron processor was introduced to create new market for affordable computing and it co-exists with high performance processors. However, social media interfaces have completely taken over conventional communication channels. Likewise, will blockchain create new market or will simplify, optimize or change existing market or business practices? If it does create new markets, it qualifies to be a disruptive innovation

Acceptability refers to a state where the disruption begins as a result of acceptance of the technology or business model by customers due to its reliability, performance, legality and affordability. eCommerce is booming today as the list of products and services that we could purchase is traded over the internet securely. This was not the case at the beginning of the millennium. Is blockchain as immutable as it sounds and pervasive legally and commercially? Certainly it is a long way to go.

Exponential improvements: A very favorite idea that is widely experimented today is driverless cars. Two key components of driverless cars are LIDAR sensors that scan 360 degrees around the vehicle and the onboard computers that processes input from sensors and actuate mechanics of the car. Both these technologies have improved leaps and bounds within a span of few years. Early models of Lidars are large moving devices that are mounted on roof of cars. New Lidars that would be available shortly are solid state and would be in the size of a postal stamp. The price have crashed from about $ 70,000 to $ 90. A computer with one teraflop performance capability occupied a room of about 1400 square feet. Recently we see announcements of 320 teraflop processors in the size of a car number plate. These exponential improvements are accelerating the disruptive capability of the innovation. And these happen over a period of time. Performance, security and reliability of blockchain components will determine as to when blockchain will be accepted as a mainstream technology

Convergence refers to situation where innovations disrupt conventional practices due to aggregation of innovations. Uber brought together cloud and smartphones to create new customer experience. Sensors, cameras, mobile internet, WhatsApp, Skype etc. converged to provide smartphones in the form we have it today. Lidars, high teraflop computing and battery capacities will give birth to practical driverless cars. So does technologies such as hyper converged infrastructure, DevOps, docker container, IoT, in-memory computing and artificial intelligence can potentially provide the expected convergence to make blockchain a disruptive force

Last but not the least, emergence of newer business models signals the arrival of disruption. If blockchain or if we can use the term ‘hyper converged blockchain’ has passed through the above definitions and characteristics of innovative disruption, then newer business models are bound to surface. This can result in creation of newer markets or tactics of survival for existing markets. If we trigger imagination on disruptions that blockchain could cause, it is really mind-boggling. Banks who will lose the ‘trusted agency’ role due to blockchain and can turn custodians or marketplace for blockchain enabled transactions. They may be a liaising house for cross border transactions. Law firms can turn into smart-contract factories. Audit firms can provide ‘auditing at source’ gateways. Blockchain can disrupt insurance contracting and processing as firms would face newer risks and very short term coverage options.

The application for blockchain appears plentiful and there would be endless innovations that we can witness in the coming years. But it may happen that by the time blockchain finds its feet, some other technology like the quantum computing would have shadowed all the attention blockchain has been receiving.

HOW ARE INFORMATION TECHNOLOGIES BEING USED TO CREATE THIS VALUE PROPOSITION?

Blockchain is an entirely IT based solution. The very focus of this technology is to digitize the entire business life cycle managed by Blockchain. Blockchain solutions sit on top of the Internet Technology and connects all the Users of the solutions through Internet.

Adoption of Blockchain for a firm is a Strategic Investment. However, for the Investment to work, traditional system will have to be replaced. So, the existing Transactional Systems will either be totally eliminated and/or they will have to repositioned in the Enterprise. Through the overhall of the Transactional System and by the nature of Blochchain, a lot of Information will be now available to the adoptors. This will mean that the firm will have to make substantial investments in Informational Systems to take advantage of the huge volume of information available. Blockchain adds cognitive analytics capabilities. In all likelyhood, by the time of adoption of Blockchain, most firms using IT Infrastructure will have moved to adopt Infrastructure from the Cloud. So, the investment in Infrastructure would be focused towards acquiring a piece of the cloud, rather than spend additional funds on on-premise equipments. However, regulators may impose certain guidelines for the maintenance of data in this ecosystem, which may entail investment in Infrastructure (For example, in the Telecom World, Customer Data and Call Data of any Telecom Operator of a Country cannot be stored anywhere outside the Country).

The Linux Group has set up an open source platform through the Hyperledger initiative, where anyone can create Blockchain solutions using Hyperledger Composer and run them through Hyperledger Fusion. The platform has membership of leading companies including IBM, Accenture, Siemens, etc. and are contributing to the enhanvement of the same. The complete code for this platform is maintained on GitHub and is available for anyone wanting to add to the platform.

BlockchainEcosystem

REVENUE AND PROFIT DRIVERS

BlockchainRevenue

The picture above shows the different players in the value chain and who can generate revenue from the adoption of the Blockchain technology adoption.

In the decentralised exonomy, there will be protocols, which are basically open-source, portable, and reusable software codified rules, that replace the proprietary systems that dominate our current landscape. One of the most obvious ways this will be monetized is via so-called “crypto-tokens” or, the more benign, “digital assets”. The protocol creators will hold a portion of the tokens for themselves and get to profit from the future value creation. The number of tokens the protocol creators receive will be transparently available for inspection by anyone via a blockchain. That way, anyone can decide if it’s too much (they are being greedy) or if it’s not enough (they won’t stick around).

Others blockchain-based businesses will develop the protocol and not issue tokens. Instead, they will attempt to monetise via the app layer. The App creator will get value from the payments in creating the most valuable application for interfacing with the protocols below it.

NATURE OF THE INNOVATION

A World Economic Forum report from September 2015 predicted that by 2025 ten percent of global GDP would be stored on blockchains technology.

In early 2017, Harvard Business School professors Marco Iansiti and Karim R. Lakhani said the blockchain is not a disruptive technology that undercuts the cost of an existing business model, but is a foundational technology that “has the potential to create new foundations for our economic and social systems”. They further predicted that, while foundational innovations can have enormous impact, it will take decades for blockchain to seep into our economic and social infrastructure.

Blockchain technology has a large potential to transform business operating models in the long term. Blockchain distributed ledger technology is more a foundational technology—with the potential to create new foundations for global economic and social systems—than a disruptive technology, which typically “attack a traditional business model with a lower-cost solution and overtake incumbent firms quickly”. Even so, there are a few operational products maturing from proof of concept by late 2016. The use of blockchains promises to bring significant efficiencies to global supply chains, financial transactions, asset ledgers and decentralized social networking.

Some observers remain skeptical. Steve Wilson, of Constellation Research, believes the technology has been hyped with unrealistic claims. To mitigate risk businesses are reluctant to place blockchain at the core of the business structure.

This means specific blockchain applications may be a disruptive innovation, because substantially lower-cost solutions can be instantiated, which can disrupt existing business models. Blockchain protocols facilitate businesses to use new methods of processing digital transactions. Examples include a payment system and digital currency, facilitating crowdsales, or implementing prediction markets and generic governance tools.

Blockchains alleviate the need for a trust service provider and are predicted to result in less capital being tied up in disputes. Blockchains have the potential to reduce systemic risk and financial fraud. They automate processes that were previously time-consuming and done manually, such as the incorporation of businesses. In theory, it would be possible to collect taxes, conduct conveyancing and provide risk management with blockchains.

As a distributed ledger, blockchain reduces the costs involved in verifying transactions, and by removing the need for trusted “third-parties” such as banks to complete transactions, the technology also lowers the cost of networking, therefore allowing several applications.

Starting with a strong focus on financial applications, blockchain technology is extending to activities including decentralised applications and collaborative organisations that eliminate a middleman.

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