Blockchain: Disruptor Version 3.0

 In Market and Investment Insights

Research analysts Ian McDonald and Tom Delong discuss the disruptive nature of blockchains and how companies can leverage the technology to gain efficiencies.

Key Takeaways

  • Blockchains are “algorithms of trust” aimed at maintaining data integrity, thus driving efficiencies across applications with large volumes of transactions or accounts
  • Blockchains can be viewed as another step of the “slim intermediary,” where the sway of middlemen is reduced by technology
  • Both private blockchains – largely the domain of existing businesses – and public blockchains – which are potentially an alternative business structure – stand to be disruptive forces across a range of industries

With the early-year hype surrounding cryptocurrencies receding, one can take a measured assessment of how digital currency along with its underlying technology – the blockchain – may impact, redefine or even replace existing business models. The answer is potentially a lot.

Blockchains can be defined as an “algorithm of trust.” Just as software has introduced efficiencies in other commercial functions, algorithms now stand to do the same with data integrity via blockchain technology. It does so by leveraging encrypted, shared databases to build a ledger that is easy to track and difficult to compromise.

It is important to differentiate between public and private ledgers. The former are open to all and base their verification standards on complex protocols that require users to commit resources to ensure the integrity of the blockchain. Cryptocurrencies utilize public ledgers. Garnering less attention are private ledgers. Rather than relying upon the intricate equations to maintain data integrity, these ledgers are permissioned, meaning that a private set of users are allowed access based upon their reputation. Private ledgers are largely the domain of individual companies or industry groups.

Each of these types of ledgers has the potential to cause significant disruption. Private ledgers are already being utilized to drive efficiencies across a range of industries, delivering value to customers and vendors. Public ledgers, on the other hand, could be even more disruptive as they may proffer an entirely different organizational structure for businesses.

Private Ledgers: Driving Efficiencies

Operating largely behind the scenes, private blockchains are seen as optimization tools in industries and processes that involve large sets of data. Financial services is an example of where the volume of accounts and transactions – along with the need for data integrity – merit the deployment of blockchains to gain efficiencies and cut costs. Already, the industry has formed consortiums to create blockchains to meet particular operational needs.

Private – or reputation-based – ledgers have an advantage over their public counterparts with regard to the speed in which entries are validated. This is relevant for financial services where transactions must be completed in seconds. Blockchains also stand to increase the utilization of a company’s fixed assets, which, in turn, can lead to either improved margins or pricing advantages.

Rather than reshuffling industries, private blockchains are being developed by leading firms in efforts to maintain their positions. Investors should take note of how management teams deploy these resources with the aim of streamlining operations much in the manner that the shift from on-premises servers to the cloud has done in recent years.

Public Ledgers: Much More than Cryptocurrencies

Much of the spotlight has fallen upon public blockchains, and rightly so. While these are readily categorized as cryptocurrencies, a more apt description could be the next step in the evolution of online marketplaces. In this respect, public blockchains are the continuation of the “slim intermediary,” a business model that delivers efficiencies by eliminating high-margin middlemen. Early adopters of this strategy were Costco, Dell and Southwest Airlines. With the growth of e-commerce, the next phase of disintermediation saw the likes of Amazon and online marketplaces emerge.

Where blockchains diverge from marketplaces – and how they could ultimately replace them – is the alignment between usage and value. As blockchains are not companies, they have no incentive to expand margins to chase profits. Instead, their goal is to squeeze margins, thus driving value to both customers and venders. This, in turn, broadens the appeal of the underlying service, increasing the value of the network in the process. This virtuous circle is premised on the concept that a network’s value is an exponential function of the number of its users.


The Token: A Dual Role

The mechanism that propels the relationship between usage and value is the token. On one hand, it is the medium of exchange for a network’s services. Tokens also serve as a unit of investment. As demand for the services underpinning the network grows, so should the value of the tokens. This appreciation is what replaces profits. While users accumulate tokens to access the network’s services, investors may choose to purchase them for speculative purposes. Often these goals are aligned, making the blockchain-based network more like a mutually owned enterprise. It is here that blockchain presents the greatest opportunity for disruption, with ownerless, algorithm-driven marketplaces providing an alternative organizational structure to the joint stock company that dominates modern business.

A Catalyst for Startups

Tokens are also a potential source of funding for startups. Historically, startup financing has been expensive and difficult to come by for entrepreneurs, and for investors, illiquid and largely limited to venture capitalists. Issuing tokens through an initial coin offering stands to improve liquidity and tap a wider investor base, many of whom may also be customers, and thus have an interest in the enterprise succeeding. This democratization of startup financing is an example of the disintermediation created by blockchains, as the returns required by venture capital present ripe targets.

Plenty of Room

While business models premised on blockchain may ultimately provide an alternative organizational structure, they are not a panacea. Instead, blockchain will likely prove advantageous for many applications, but traditional companies will be appropriate for others. Blockchains’ beneficial characteristics, such as pricing advantages and the alignment between buyers and sellers, are just a few among many factors determining success. Strong existing businesses can continue to leverage networks, wide moats, superior user experiences and the ability to hire talent to defend their position. There is presently little near-term threat to publically traded companies, but investors would be wise to monitor future developments of potentially revolutionary public blockchains. At the same time, they would be well-served to identify which companies are leveraging the power of private blockchains to drive efficiencies and deliver shareholder value.

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