GUEDDA HASSAN MOHAMED
Cotracts, transactions, and the records of them are
among the defining structures in our economic, legal, and political systems. They
protect assets and set organizational boundaries. They establish and verify
identities and chronicle events. They govern interactions among nations,
organizations, communities, and individuals. They guide managerial and social
action. And yet these critical tools and the bureaucracies formed to manage
them have not kept up with the economy’s digital transformation. They’re like a
rush-hour gridlock trapping a Formula 1 race car. In a digital world, the way
we regulate and maintain administrative control has to change.
Blockchain promises to solve this problem. The
technology at the heart of bitcoin and other virtual currencies, blockchain is
an open, distributed ledger that can record transactions between two parties
efficiently and in a verifiable and permanent way. The ledger itself can also
be programmed to trigger transactions automatically.
With blockchain, we can imagine a world in which
contracts are embedded in digital code and stored in transparent, shared
databases, where they are protected from deletion, tampering, and revision. In
this world every agreement, every process, every task, and every payment would
have a digital record and signature that could be identified, validated,
stored, and shared. Intermediaries like lawyers, brokers, and bankers might no
longer be necessary. Individuals, organizations, machines, and algorithms would
freely transact and interact with one another with little friction. This is the
immense potential of blockchain.
Indeed, virtually everyone has heard the claim that
blockchain will revolutionize business and redefine companies and economies.
Although we share the enthusiasm for its potential, we worry about the hype.
It’s not just security issues (such as the 2014 collapse of one bitcoin
exchange and the more recent hacks of others) that concern us. Our experience
studying technological innovation tells us that if there’s to be a blockchain
revolution, many barriers—technological, governance, organizational, and even
societal—will have to fall. It would be a mistake to rush headlong into
blockchain innovation without understanding how it is likely to take hold.
True blockchain-led transformation of business and
government, we believe, is still many years away. That’s because blockchain is
not a “disruptive” technology, which can attack a traditional business model
with a lower-cost solution and overtake incumbent firms quickly. Blockchain is
a foundational technology: It has the potential to
create new foundations for our economic and social systems. But while the impact
will be enormous, it will take decades for blockchain to seep into our economic
and social infrastructure. The process of adoption will be gradual and steady,
not sudden, as waves of technological and institutional change gain momentum.
That insight and its strategic implications are what we’ll explore in this
article.
Patterns of Technology Adoption
Before jumping into blockchain strategy and
investment, let’s reflect on what we know about technology adoption and, in
particular, the transformation process typical of other foundational
technologies. One of the most relevant examples is distributed computer
networking technology, seen in the adoption of TCP/IP (transmission control
protocol/internet protocol), which laid the groundwork for the development of
the internet.
Introduced in 1972, TCP/IP first gained traction in a single-use case: as the basis for e-mail among
the researchers on ARPAnet, the U.S. Department of Defense precursor to the
commercial internet. Before TCP/IP, telecommunications architecture was based
on “circuit switching,” in which connections between two parties or machines
had to be preestablished and sustained throughout an exchange. To ensure that
any two nodes could communicate, telecom service providers and equipment
manufacturers had invested billions in building dedicated lines.
TCP/IP turned that model on its head. The new protocol
transmitted information by digitizing it and breaking it up into very small
packets, each including address information. Once released into the network,
the packets could take any route to the recipient. Smart sending and receiving
nodes at the network’s edges could disassemble and reassemble the packets and
interpret the encoded data. There was no need for dedicated private lines or
massive infrastructure. TCP/IP created an open, shared public network without
any central authority or party responsible for its maintenance and improvement.
Traditional telecommunications and computing sectors
looked on TCP/IP with skepticism. Few imagined that robust data, messaging,
voice, and video connections could be established on the new architecture or
that the associated system could be secure and scale up. But during the late
1980s and 1990s, a growing number of firms, such as Sun, NeXT, Hewlett-Packard,
and Silicon Graphics, used TCP/IP, in part to create localized private networks within
organizations. To do so, they developed building blocks and tools that
broadened its use beyond e-mail, gradually replacing more-traditional local
network technologies and standards. As organizations adopted these building
blocks and tools, they saw dramatic gains in productivity.
TCP/IP burst into broad public use with the advent of
the World Wide Web in the mid-1990s. New technology companies quickly emerged
to provide the “plumbing”—the hardware, software, and services needed to
connect to the now-public network and exchange information. Netscape
commercialized browsers, web servers, and other tools and components that aided
the development and adoption of internet services and applications. Sun drove
the development of Java, the application-programming language. As information
on the web grew exponentially, Infoseek, Excite, AltaVista, and Yahoo were born
to guide users around it.
Once this basic infrastructure gained critical mass, a
new generation of companies took advantage of low-cost connectivity by creating
internet services that were compelling substitutes for
existing businesses. CNET moved news online. Amazon offered more books for sale
than any bookshop. Priceline and Expedia made it easier to buy airline tickets
and brought unprecedented transparency to the process. The ability of these
newcomers to get extensive reach at relatively low cost put significant
pressure on traditional businesses like newspapers and brick-and-mortar
retailers.
Relying on broad internet
connectivity, the next wave of companies created novel, transformative applications that fundamentally
changed the way businesses created and captured value. These companies were
built on a new peer-to-peer architecture and generated value by coordinating
distributed networks of users. Think of how eBay changed online retail through
auctions, Napster changed the music industry, Skype changed telecommunications,
and Google, which exploited user-generated links to provide more relevant
results, changed web search.
Companies are already using blockchain to track items through complex supply chains.
Ultimately, it took more than 30 years for TCP/IP to move through all
the phases—single use, localized use, substitution, and transformation—and
reshape the economy. Today more than half the world’s most valuable public
companies have internet-driven, platform-based business models. The very
foundations of our economy have changed. Physical scale and unique intellectual
property no longer confer unbeatable advantages; increasingly, the economic
leaders are enterprises that act as “keystones,” proactively organizing,
influencing, and coordinating widespread networks of communities, users, and
organizations.
The New Architecture
Blockchain—a peer-to-peer network that
sits on top of the internet—was introduced in October 2008 as part of a
proposal for bitcoin, a virtual currency system that eschewed a central
authority for issuing currency, transferring ownership, and confirming
transactions. Bitcoin is the first application of blockchain technology.
The parallels between blockchain and
TCP/IP are clear. Just as e-mail enabled bilateral messaging, bitcoin enables
bilateral financial transactions. The development and maintenance of blockchain
is open, distributed, and shared—just like TCP/IP’s. A team of volunteers
around the world maintains the core software. And just like e-mail, bitcoin
first caught on with an enthusiastic but relatively small community.
TCP/IP unlocked new economic value by
dramatically lowering the cost of connections. Similarly, blockchain could
dramatically reduce the cost of transactions. It has the potential to become
the system of record for all transactions. If that happens, the economy will
once again undergo a radical shift, as new, blockchain-based sources of
influence and control emerge.
Consider how business works now. Keeping
ongoing records of transactions is a core function of any business. Those
records track past actions and performance and guide planning for the future.
They provide a view not only of how the organization works internally but also
of the organization’s outside relationships. Every organization keeps its own
records, and they’re private. Many organizations have no master ledger of all
their activities; instead records are distributed across internal units and
functions. The problem is, reconciling transactions across individual and
private ledgers takes a lot of time and is prone to error.
For example, a typical stock transaction
can be executed within microseconds, often without human intervention. However,
the settlement—the ownership transfer of the stock—can take as long as a week.
That’s because the parties have no access to each other’s ledgers and can’t
automatically verify that the assets are in fact owned and can be transferred.
Instead a series of intermediaries act as guarantors of assets as the record of
the transaction traverses organizations and the ledgers are individually
updated.
In a blockchain system, the ledger is
replicated in a large number of identical databases, each hosted and maintained
by an interested party. When changes are entered in one copy, all the other
copies are simultaneously updated. So as transactions occur, records of the
value and assets exchanged are permanently entered in all ledgers. There is no
need for third-party intermediaries to verify or transfer ownership. If a stock
transaction took place on a blockchain-based system, it would be settled within
seconds, securely and verifiably. (The infamous hacks that have hit bitcoin
exchanges exposed weaknesses not in the blockchain itself but in separate
systems linked to parties using the blockchain.)
A Framework for Blockchain Adoption
If bitcoin is like early e-mail, is
blockchain decades from reaching its full potential? In our view the answer is
a qualified yes. We can’t predict exactly how many years the transformation
will take, but we can guess which kinds of applications will gain traction
first and how blockchain’s broad acceptance will eventually come about.
In our analysis, history suggests that two dimensions affect how a
foundational technology and its business use cases evolve. The first is
novelty—the degree to which an application is new to the world. The more novel
it is, the more effort will be required to ensure that users understand what
problems it solves. The second dimension is complexity, represented by the
level of ecosystem coordination involved—the number and diversity of parties
that need to work together to produce value with the technology. For example, a
social network with just one member is of little use; a social network is
worthwhile only when many of your own connections have signed on to it. Other
users of the application must be brought on board to generate value for all
participants.
The same will be true for many blockchain applications. And, as
the scale and impact of those applications increase, their adoption will
require significant institutional change.
We’ve developed a framework that maps
innovations against these two contextual dimensions, dividing them into
quadrants. (See the exhibit “How Foundational Technologies Take Hold.”) Each
quadrant represents a stage of technology development. Identifying which one a
blockchain innovation falls into will help executives understand the types of
challenges it presents, the level of collaboration and consensus it needs, and
the legislative and regulatory efforts it will require. The map will also
suggest what kind of processes and infrastructure must be established to
facilitate the innovation’s adoption. Managers can use it to assess the state
of blockchain development in any industry, as well as to evaluate strategic
investments in their own blockchain capabilities.
Single use.
In the first quadrant are low-novelty
and low-coordination applications that create better, less costly, highly
focused solutions. E-mail, a cheap alternative to phone calls, faxes, and snail
mail, was a single-use application for TCP/IP (even though its value rose with
the number of users). Bitcoin, too, falls into this quadrant. Even in its early
days, bitcoin offered immediate value to the few people who used it simply as
an alternative payment method. (You can think of it as a complex e-mail that
transfers not just information but also actual value.) At the end of 2016 the
value of bitcoin transactions was expected to hit $92 billion. That’s still a
rounding error compared with the $411 trillion in total global payments, but
bitcoin is growing fast and increasingly important in contexts such as instant
payments and foreign currency and asset trading, where the present financial
system has limitations.
Localization.
The second quadrant comprises
innovations that are relatively high in novelty but need only a limited number
of users to create immediate value, so it’s still relatively easy to promote
their adoption. If blockchain follows the path network technologies took in
business, we can expect blockchain innovations to build on single-use
applications to create local private networks on which multiple organizations
are connected through a distributed ledger.
Much of the initial private blockchain-based development is taking place
in the financial services sector, often within small networks of firms, so the
coordination requirements are relatively modest. Nasdaq is working with
Chain.com, one of many blockchain infrastructure providers, to offer technology
for processing and validating financial transactions. Bank of America, JPMorgan,
the New York Stock Exchange, Fidelity Investments, and Standard Chartered are
testing blockchain technology as a replacement for paper-based and manual
transaction processing in such areas as trade finance, foreign exchange,
cross-border settlement, and securities settlement. The Bank of Canada is
testing a digital currency called CAD-coin for interbank transfers.
We
anticipate a proliferation of private blockchains that serve specific purposes
for various industries.
Substitution.
The third quadrant contains applications
that are relatively low in novelty because they build on existing single-use
and localized applications, but are high in coordination needs because they
involve broader and increasingly public uses. These innovations aim to replace
entire ways of doing business.
They face high barriers to adoption, however;
not only do they require more coordination but the processes they hope to
replace may be full-blown and deeply embedded within organizations and
institutions. Examples of substitutes include cryptocurrencies—new, fully
formed currency systems that have grown out of the simple bitcoin payment
technology. The critical difference is that a cryptocurrency requires every
party that does monetary transactions to adopt it, challenging governments and
institutions that have long handled and overseen such transactions. Consumers
also have to change their behavior and understand how to implement the new
functional capability of the cryptocurrency.
A recent experiment at MIT highlights
the challenges ahead for digital currency systems. In 2014 the MIT Bitcoin Club
provided each of MIT’s 4,494 undergraduates with $100 in bitcoin.
Interestingly, 30% of the students did not even sign up for the free money, and
20% of the sign-ups converted the bitcoin to cash within a few weeks. Even the
technically savvy had a tough time understanding how or where to use bitcoin.
One of the most ambitious substitute
blockchain applications is Stellar, a nonprofit that aims to bring affordable
financial services, including banking, micropayments, and remittances, to
people who’ve never had access to them. Stellar offers its own virtual
currency, lumens, and also allows users to retain on its system a range of
assets, including other currencies, telephone minutes, and data credits.
Stellar initially focused on Africa, particularly Nigeria, the largest economy
there. It has seen significant adoption among its target population and proved
its cost-effectiveness. But its future is by no means certain, because the
ecosystem coordination challenges are high. Although grassroots adoption has
demonstrated the viability of Stellar, to become a banking standard, it will
need to influence government policy and persuade central banks and large
organizations to use it. That could take years of concerted effort.
Transformation.
Into the last quadrant fall completely
novel applications that, if successful, could change the very nature of
economic, social, and political systems. They involve coordinating the activity
of many actors and gaining institutional agreement on standards and processes.
Their adoption will require major social, legal, and political change.
“Smart contracts” may be the most
transformative blockchain application at the moment. These automate payments
and the transfer of currency or other assets as negotiated conditions are met.
For example, a smart contract might send a payment to a supplier as soon as a
shipment is delivered. A firm could signal via blockchain that a particular
good has been received—or the product could have GPS functionality, which would
automatically log a location update that, in turn, triggered a payment. We’ve
already seen a few early experiments with such self-executing contracts in the
areas of venture funding, banking, and digital rights management.
The implications are fascinating. Firms
are built on contracts, from incorporation to buyer-supplier relationships to
employee relations. If contracts are automated, then what will happen to
traditional firm structures, processes, and intermediaries like lawyers and
accountants? And what about managers? Their roles would all radically change.
Before we get too excited here, though, let’s remember that we are decades away
from the widespread adoption of smart contracts. They cannot be effective, for instance,
without institutional buy-in. A tremendous degree of coordination and clarity
on how smart contracts are designed, verified, implemented, and enforced will
be required. We believe the institutions responsible for those daunting tasks
will take a long time to evolve. And the technology challenges—especially
security—are daunting.
Guiding Your Approach to Blockchain
Investment
How should executives think about
blockchain for their own organizations? Our framework can help companies
identify the right opportunities.
For most, the easiest place to start is
single-use applications, which minimize risk because they aren’t new and
involve little coordination with third parties. One strategy is to add bitcoin
as a payment mechanism. The infrastructure and market for bitcoin are already
well developed, and adopting the virtual currency will force a variety of
functions, including IT, finance, accounting, sales, and marketing, to build
blockchain capabilities. Another low-risk approach is to use blockchain internally
as a database for applications like managing physical and digital assets,
recording internal transactions, and verifying identities. This may be an
especially useful solution for companies struggling to reconcile multiple
internal databases. Testing out single-use applications will help organizations
develop the skills they need for more-advanced applications. And thanks to the
emergence of cloud-based blockchain services from both start-ups and large
platforms like Amazon and Microsoft, experimentation is getting easier all the
time.
Localized applications are a natural next step for companies. We’re
seeing a lot of investment in private blockchain networks right now, and the
projects involved seem poised for real short-term impact. Financial services
companies, for example, are finding that the private blockchain networks
they’ve set up with a limited number of trusted counterparties can
significantly reduce transaction costs.
Organizations can also tackle specific
problems in transactions across boundaries with localized applications.
Companies are already using blockchain to track items through complex supply
chains, for instance. This is happening in the diamond industry, where gems are
being traced from mines to consumers. The technology for such experiments is
now available off-the-shelf.
Developing substitute applications
requires careful planning, since existing solutions may be difficult to
dislodge. One way to go may be to focus on replacements that won’t require end
users to change their behavior much but present alternatives to expensive or
unattractive solutions. To get traction, substitutes must deliver functionality
as good as a traditional solution’s and must be easy for the ecosystem to
absorb and adopt. First Data’s foray into blockchain-based gift cards is a good
example of a well-considered substitute.
Retailers that offer them to consumers
can dramatically lower costs per transaction and enhance security by using
blockchain to track the flows of currency within accounts—without relying on
external payment processors. These new gift cards even allow transfers of
balances and transaction capability between merchants via the common ledger.
Blockchain could slash the cost of transactions and reshape the economy.
Transformative applications are still
far away. But it makes sense to evaluate their possibilities now and invest in
developing technology that can enable them. They will be most powerful when
tied to a new business model in which the logic of value creation and capture
departs from existing approaches. Such business models are hard to adopt but
can unlock future growth for companies.
Consider how law firms will have to
change to make smart contracts viable. They’ll need to develop new expertise in
software and blockchain programming. They’ll probably also have to rethink
their hourly payment model and entertain the idea of charging transaction or
hosting fees for contracts, to name just two possible approaches. Whatever tack
they take, executives must be sure they understand and have tested the business
model implications before making any switch.
Transformative scenarios will take off
last, but they will also deliver enormous value. Two areas where they could have
a profound impact: large-scale public identity systems for such functions as
passport control, and algorithm-driven decision making in the prevention of
money laundering and in complex financial transactions that involve many
parties. We expect these applications won’t reach broad adoption and critical
mass for at least another decade and probably more.
Transformative applications will also
give rise to new platform-level players that will coordinate and govern the new
ecosystems. These will be the Googles and Facebooks of the next generation. It
will require patience to realize such opportunities. Though it may be premature
to start making significant investments in them now, developing the required
foundations for them—tools and standards—is still worthwhile.
CONCLUSION
In addition to providing a good template
for blockchain’s adoption, TCP/IP has most likely smoothed the way for it.
TCP/IP has become ubiquitous, and blockchain applications are being built on
top of the digital data, communication, and computation infrastructure, which
lowers the cost of experimentation and will allow new use cases to emerge
rapidly.
With our framework, executives can
figure out where to start building their organizational capabilities for
blockchain today. They need to ensure that their staffs learn about blockchain,
to develop company-specific applications across the quadrants we’ve identified,
and to invest in blockchain infrastructure.
But given the time horizons, barriers to
adoption, and sheer complexity involved in getting to TCP/IP levels of
acceptance, executives should think carefully about the risks involved in
experimenting with blockchain. Clearly, starting small is a good way to develop
the know-how to think bigger. But the level of investment should depend on the
context of the company and the industry. Financial services companies are
already well down the road to blockchain adoption. Manufacturing is not.
No matter what the context, there’s a
strong possibility that blockchain will affect your business. The very
big question is when.
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