Blockchain Technology: Benefits, Risks, and Business Applications

Introduction

One of the most talked-about emerging technologies is the blockchain. Originally developed for Bitcoin, blockchain shows a tremendous amount of promise in terms of reducing certain types of friction, especially in business (Marr, 2018). Over the past couple of years, blockchain has been unpacked from cryptocurrency and a wealth of applications using the technology are in development. Many observers predict that blockchain technology will revolutionize a wide range of businesses (Marr, 2018).

What Is Blockchain?

The heart of blockchain is the concept of the distributed ledger. The original idea behind Bitcoin was to develop a peer-to-peer currency — a store of value and unit of exchange that could be created without the intermediary of a central bank. The value of this currency would be determined by the forces of supply and demand, based strictly on its users, without the influence of interest rates and other monetary policy tools that central banks use to influence the value of their currencies. The way to resolve the issue of trust that naturally arises from a lack of a central bank, or any underlying asset, is the concept of the distributed ledger.

The value of Bitcoin could not be established on a peer-to-peer basis alone. The counterparties, even if known to each other, would have no legal basis for establishing that value, and in any case there would be no dispute resolution mechanism between them. The distributed ledger concept was developed to work around this problem. A distributed ledger is one where all of the participants in the blockchain hold copies of a transaction. Trust is based, therefore, on having a large number of records of any given transaction. These records are immutable, and the distributed nature means that a large number of people can attest to the value of the transaction. This enforces honesty — it is very difficult to challenge the value and terms of a transaction when hundreds of people have access to it.

Trust is therefore developed on the principle that counterparties are not automatically to be trusted. Consider how this works for a blockchain contract. The contract will be recorded by dozens or more members of the blockchain. In a normal paper contract, the counterparties sign the document, but those copies are the only public record. If there is a dispute, the original document is taken along with the nature of the dispute to court, and resolved through interpreting the meaning of the contract and whether its conditions have been fulfilled. In blockchain, it is understood that the counterparties cannot trust each other, but there are hundreds of others who have access to that same contract. There can be no dispute, in theory, about what the contract contains. This is obviously an oversimplification of how blockchain contracts would work, but it illustrates the potential of the technology to perform everyday functional business tasks in a completely different way — essentially crowdsourcing trust.

Benefits of Blockchain

The reason that blockchain technology holds so much promise in business is because it offers certain benefits of particular interest to the business community. The three main ones are transparency, immutability, and efficiency. The argument that blockchain is more transparent than other technologies relates to the public nature of the transaction. While the identities of the participants are hidden behind cryptography, the transaction itself is not. A participant's transaction history is visible, so that a counterparty can review this history prior to entering into a transaction. Identity may not be known, but transaction history is, and that creates a level of transparency that often does not exist outside of blockchain (Lisk, 2018). This transparency has been touted as especially valuable in supply chain applications: as goods move through the supply chain, the buyer can see the entire history of those goods and verify that quality and authenticity have been confirmed at each step. Benefits include a reduction in counterfeit goods, higher levels of quality assurance even in complex supply chains, and lower legal risk because of the transparency and immutability of the information (Lisk, 2018).

The immutability factor is also one of the key benefits of blockchain. The distributed nature of the ledger means that there are multiple records of any given transaction. If someone wants to alter a transaction after the fact, they would have to change every one of those records. Hacking one or two might be possible, but altering all of them in order to create a false record is much more difficult. This is why blockchain is considered immutable — cryptography makes altering completed transactions nearly impossible (Comben, 2018).

The immutability claim has, however, been challenged. While blockchains are touted as immutable, the consensus nature of a blockchain means that 51% attacks can occur — where only 51% of the records need to be altered for the false transaction to become the accepted one within the blockchain by virtue of simple majority (Comben, 2018). Another means of altering transactions is forking, where the blockchain agrees to rewrite history, as occurred when Ethereum was hacked and the entire blockchain was rewritten to omit the hack. If a majority of participants agree to forking, the altered transaction will be accepted, again illustrating that the immutability of blockchain is more conceptual than absolute. The key point is that blockchain may not be 100% immutable, but it is a significant improvement over existing bilateral ledgers, which are often relatively insecure.

The final benefit touted for blockchain is efficiency. This is somewhat illusory. Blockchains are deemed efficient because the distributed ledger system cuts out the middleman in transactions. The role of the middleman is often to facilitate a transaction between two parties, for which a fee is charged. Blockchains rely on a different system of trust, and many transactions that previously required an intermediary no longer do. The counterparties thus save money on transaction fees, commissions, or other mechanisms by which the middleman was paid.

The problem, of course, is apparent. There might not be transaction costs in the form of fees and commissions for recording blockchain transactions, but there are costs. Those costs — notably the power consumed to record a transaction hundreds more times than it would normally be recorded — are offloaded onto power grids, public utilities, and the participants in the blockchain. This inefficiency is a negative externality that gives blockchains the appearance of efficiency while actually making them less efficient overall (Miller, 2018). That said, this is a recognized issue in the blockchain community, and many companies are working to resolve the energy problem (Miller, 2018; Zhao, 2018). If energy consumption can be reduced, the transactional efficiency afforded by blockchain will be realized more effectively.

Conclusion

These innovation pathways may not be fully developed yet, but the idea of the distributed ledger holds a lot of promise, and people have only just begun thinking about different ways to leverage this technology. The reality is that distributed ledger technology is something that will underpin a wide variety of applications. For some purposes blockchain holds more promise than for others, but most experts appear to share the view that blockchain can and will disrupt a large number of industries. Where intermediaries make money simply for being intermediaries, the peer-to-peer nature of blockchain is clearly an existential threat — and the wide-ranging potential uses of peer-to-peer asset movement make that threat even more powerful.

It will be interesting to see how the blockchain landscape unfolds in the next few years. Blockchain has enormous potential, but the number of current applications remains fairly limited. Major enterprise companies like Oracle and Cisco already have blockchain programs underway, and these will likely be among the first to bring blockchain into the mainstream and eventually to the enterprise at large.

Contracts appear to be among the first uses that will hit the mainstream, but even with smart contracts there are issues that need to be resolved. Even in areas where blockchain technology holds competitive advantage — such as security — there are unresolved challenges. So while there is tremendous promise, and a great deal of capital being invested in development, blockchain remains a nascent technology, still awaiting the applications that can transform it into the powerful business tool that many predict it will become.