Blockchain – Time to Jump In
You will definitely be using blockchain technology in the next five years, and the seeds are being planted right now. Ignorance is no defense so it’s time to get smart on this technology.
Why is blockchain coming up so often these days?
We live in a world of transaction costs and headaches. You buy something with a Visa card overseas, and you’ve instantly created five ledger entries – for you, the merchant, your bank, the merchant’s bank, and Visa. Somewhere in the middle of this is a currency exchange over which you have no control. On top of it all are the charges levied by Visa and other intermediaries. Conversely, in the blockchain world, there is one ledger entry for the transfer of a blockchain-based currency (e.g. Bitcoin) from you to the merchant. No reconciliation, no settlement, no currency exchange.
The underlying power of this idea has driven $1.3bn of crowdfunding investment into over 75 blockchain-based firms in this year alone (as of mid-July 2017). These firms cover everything from new currencies to identity management to logistics to healthcare. On a side note, you’ll hear more and more about Initial Coin Offerings, or ICOs, as this funding option goes more mainstream.
Yes, it’s 1999 in blockchain world. The equivalents of Amazon, Google, and Salesforce.com have been founded … and so have the Webvans. While there’s plenty of froth, the smart money was around in 1999 and hasn’t forgotten the dot-com crash.
You’re not in imminent danger of being thrown out into the streets, especially in the slower-moving energy world, but blockchain years are faster than Internet years, so don’t expect to have the luxury of five years to mull this over.
Lest you think it’s all hype, there is a full head of steam behind blockchain, judging by the blue-chip roster of HyperLedger members (e.g. Accenture, American Express, Daimler, Huawei, IBM, Kaiser Permanente, and SAP) and Energy Web Foundation supporters (Centrica, Engie, Shell, Statoil, and Tepco). Delaware has just adopted a law that recognizes the trading of stocks on the blockchain.
The basics of the technology
When someone says “blockchain”, you should think “Distributed Ledger”, a way to pull transaction records, smart contracts, and provenance out of centralized databases and into the hands of participants. The ledgers are maintained by each participant in a network. The genius of blockchain is that it ensures these distributed ledgers are synced up and highly secure. Think of all of the work done by centralized systems to ensure trust. Blockchain removes much of that value proposition.
“Distributed ledgers – or decentralized databases – are systems that enable parties who don’t fully trust each other to form and maintain consensus about the existence, status and evolution of a set of shared facts.”
In other words, blockchain technology allows connected devices to reach agreement over shared data.
A centralized world goes peer-to-peer
A couple of diagrams will help. Here’s the current world for most of us, with browsers of various types accessing increasing sophisticated data and tools from a central database.
And here’s how it looks in the blockchain world, where a distributed database is synchronized across multiple nodes without a central manager:
The key elements of blockchain
The simple formulation is that blockchain technology allows connected devicesto reach agreement over shared data. Without getting too techy, let’s dig in on those three critical pieces.
Connected Devices are in a peer-to-peer network. If your computer or phone or smart meter is a part of a blockchain network, it is communicating directly to other devices on that network, not through a central server owned by a third party.
Agreement between all of the connected computers is based on a consensus mechanism. One of the challenges of distribution is that the ledgers can get out of sync. Blockchain includes a specific process for managing agreement over time. This is a non-trivial exercise. Any time you see “Proof-of-X” associated with blockchain, you’re looking at innovations designed to improve the syncing process.
Shared Data in the form of a chain of blocks (surprise, surprise). A blockchain network maintains data, transactions, and contracts in a specific format so participants can verify the consistency of a growing ledger. Each new entry must always reference earlier entries, creating a linked chain of data. The links along the chain are encrypted in a specific way, so that if someone tries to change an earlier entry, the whole chain breaks. The consensus mechanism in the paragraph above will then reject that change, ensuring that the ledger remains intact.
Advanced cryptography underlies all of this. Turning to Richard Brown of R3 again: “We believe that the maturation of cryptographic techniques … provides a new opportunity: the possibility of authoritative systems of record that are securely shared between firms.”
The Value of Blockchain
IBM is heavily invested in blockchain. They talk about four key values of the technology:
- Consensus, i.e. allowing multiple parties to automatically approve new records being added to the ledger.
- Provenance, i.e. maintaining a complete record of who’s owned the asset.
- Immutability, i.e. ensuring that the ledger can’t be tampered with.
- Finality, i.e. holding one single version of the truth across all the distributed ledger
I’d like to add one more:
- Smart settlement, i.e. embedding standard contract terms in the ledger so that exchanges are triggered automatically as events occur
And this leads to four key benefits:
- Saved time
- Reduced cost
- Reduced risk of tampering, fraud, hacking
- Increased trust between partners through shared processes and record-keeping
A couple of examples
If you haven’t been thinking about blockchain for a while you’re probably scratching your head. How would this really work? I’ll provide two example: one serious and one cute.
Large aerospace firms have an extended supply chain. Parts must be precisely milled, and must be tracked carefully from origin to installation. Multiple parties hold records of each part to ensure quality and allow for later troubleshooting. There is a very careful auditing process all the way along the chain.
Blockchain allows each part to be tracked in one distributed ledger that is shared by all parties. The provenance of each part is clear from the ledger records, and its passage from manufacture to installation is tamper-proof. The cost and bottlenecks of the auditing process are removed. Airbus is working on this.
This is the cute example. Your BnB has a smart lock that is part of the ledger. The lock knows that you’ll be arriving between 2 pm and 8 pm. As you approach with your phone, the cryptographic key opens the lock. The lock also knows that you’ll be departing between 10 am and Noon. As you tag out at the end of your stay, the lock bills you for the stay. The lock also knows that a cleaning service is due between 2 pm and 3 pm so allows the service to enter later. As the cleaning service tags out, the lock bills the owner of the property. Airbnb is on it.
You get the idea. In some cases, provenance and immutability are the overriding factors, while in others, consensus and smart settlement come to the fore.
But wait, what’s wrong with our current systems?
We all recognize the enormous benefits we’ve gained over the past 70 years from centralizing transactions. It’s great to have Amazon as a global marketplace or the Visa network as an intermediary between buyers and sellers. Except when it’s not:
- Cloud databases can be hacked. Need I say more? The distributed ledger is much harder to hack because the records are in so many places.
- Centralized systems can go down. Amazon, Azure, and Salesforce have all experienced severe outages in the last year or so. Blockchain is distributed to avoid this possibility.
- Centralized networks impose transaction costs. Credit card networks are an obvious case, but the real estate MLS and electric utilities are other examples. Transacting power at the edge is a key value for blockchain networks.
- Centralized networks leave auditing holes. If you buy something on Alibaba, you still have to keep your audit trail of the exchange, and the seller has to keep theirs. There is no definitive record for all parties. It’s worse for information goods, like Renewable Energy Credits, where ongoing monitoring is required. A single distributed ledger avoids the data hand-offs that drive up auditing costs.
- Network operators cater to the lowest common denominator. If you want to sell music through iTunes, you can only use their digital rights options. If you want buy your neighbor’s excess energy storage capacity, good luck. If you think a REC is worth more at 5 pm than at 2 pm, the network doesn’t offer that pricing opportunity. The distributed ledger allows for smarter contracts.
In summary, we’re looking for the trust benefits that come from large networks, but with lower costs, greater security, and more freedom to innovate.
Is blockchain the same as Bitcoin?
Let’s close Part 1 of this article with an important distinction. Most of us have heard of Bitcoin due to a security disaster in the last few years where investors lost about $450 million. But Bitcoin is not the same thing as blockchain.
Bitcoin is built on the blockchain concept of a distributed, encrypted ledger. In fact, Bitcoin was the very first implementation of the idea. Bitcoin is still running and the value of one Bitcoin has been trading around $2500 recently.
However, Bitcoin suffers from four serious problems when it comes to business transactions:
- It is a global ledger that is open to all parties. Most transactions occur in closed networks.
- It transmits transaction info to everyone on the network. In most cases, we want to control who sees which elements of our transactions.
- It promotes anonymity over identity. We typically want to know who we’re dealing with.
- It uses a lot of energy and time to add blocks because of its specific approach to security and cryptography. We’re accustomed to fast transactions and we want to reduce our energy footprint, not increase it.
As a result, Bitcoin remains useful as a global crypto-currency, but it’s not great for the vast majority of scenarios. Enter the open-source platform. So far, two main platforms have emerged for business transactions: HyperLedger, as mentioned previously, is a consortium effort that brings together large tech firms and a few early adopters, to create an open source protocol; Ethereum is a competing platform, whose Enterprise Alliance is focused on smart contracts. R3 Corda is a platform that’s specific to the financial services industry.
The next part
We’ll pick up the story in my next post with a detailed investigation of blockchain in the energy space. I’ll just leave you with this diagram to enjoy.
Diagram adapted from “Corda: An Introduction” by R3
Thanks to Energy Web Foundation, Event Horizon, Greentech Media, HyperLedger, IBM, UCL Centre for Blockchain Technologies, and Richard Brown at R3 for great resources on blockchain in commercial settings.