Digital Innovation in the Blockchain Age

Contracts, 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.

This article was originally published by Stefano Tempesta on Linkedin.

The blockchain promise

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 intermediaries 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.

The challenge ahead

In the last quarter of a century, we have seen Internet evolving from a corporate web site window to an interactive and socially connected network of individuals and organizations that share content and promote business. This brought, over time, a massification of our communication: When 20 years ago, magazines and newspapers could reach their audience only if a physical printed issue was in people’s hands, nowadays any piece of content could, potentially, reach the entire human kind. We are all connected by at last 6 degrees of separation! The challenge is under our eyes: Fakes news, dodgy businesses, online frauds… The answer?

Blockchain is an emerging technology for organizations to almost instantaneously make and verify transactions, streamlining business processes, saving money, and reducing the potential for fraud. By combining the openness of the Internet with the security of cryptography, blockchain provides everyone with a faster, safer way to perform peer-to-peer transactions.

The blockchain evolution

The Bitcoin blockchain was designed for transactions of the bitcoin crypto currency only. It has all the features of a decentralized and distributed digital ledger, but it lacks smart contracts, the business logic tier. This limitation makes it unappealing to businesses for applications besides crypto currency exchange. The advent of Ethereum and Hyperledger and the introduction of smart contracts have opened blockchain to the enterprise world, with the possibility to set rules for execution of transactions. Transactions that, now, are no longer confined to crypto currency only, but can happen for any digital asset that has a value. This opens the possibility for scenarios in supply chain, digital identity and asset management to benefit of an immutable and encrypted data source, with built-in cybersecurity provided by its distributed nature and consensus of all members. Also, “Blockchain 2.0” type of ledgers introduced the possibility to run a blockchain network in a private or consortium mode, granting that level of governance (membership, data distribution, content filtering) that a public blockchain like Bitcoin does not offer. Governance, as well as performance of the network, is a key quality for enterprises to adopt any technology platform.

Still, there is a limitation in smart contracts in the capability to access information outside of a block in the chain. Pass me a metaphor, smart contracts are similar to old-fashioned stored procedures in a database, which can access data inside the database itself, but have no visibility on external sources (I know this is different nowadays in modern databases like SQL Server, but you get the idea). The real word, though, is made of data in multiple sources, including CRM or ERP systems, web services, etc. There is no chance we can put, say, a CRM system, a monolith application, into any blockchain network. But we still may want to access its information, connect on-chain data with off-chain systems. Think of personal information (you may not want to store sensitive data on a blockchain for its immutable nature – GDPR compliance), contact / vendor / supplier or product details, etc. Blockchain represents the audit trail of your transactions, of any nature, but there is no need to store the piece of information exchanged on the blockchain itself. A link to it, in the form of an immutable hash, would suffice. This is where Microsoft comes as a pioneer, or innovator, in this field, by introducing the missing connection ring between on-chain and off-chain data, which goes under the name of “cryptlet” (although this may not be the name that hits the market).

The blockchain ideology

Some people see at blockchain, with its decentralized structure and no central ownership, as a way to their freedom of speech and expression, which is otherwise, allegedly being affected by the centralised nature of the web. Bitcoin, in Satoshi Nakamoto’s words, was created in anger at the current banking system. The message “he” wanted to send was that centralization of money is destructive and the only solution to this problem would be a truly brand-new decentralized monetary system. Bitcoin did not only solve a technological problem, but was rather a solution to more philosophical and ideological questions. It managed to create a system that lacked a central authority, while still being able to regulate itself and provide advantages to those willing to take part in it. It regulated a decentralized system while still guaranteeing its users freedom and liberty. It is technology applied to ideology. The ideology of a better world where blockchain represents a possible alternative to a centuries-long diatribe, regarding the division of power between a central authority and those who are ruled by it.

Why blockchain is better

To appreciate why it’s better than a centralized database, we need to understand how blockchain works. 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 transaction took place on a blockchain-based system, it would be settled within seconds, securely and verifiably. Blockchain technology is like the Internet in that it has a built-in robustness. By storing blocks of information that are identical across its network, a blockchain node cannot be controlled by any single entity, has no single point of failure and it provides built-in security by offering a cryptographically secure data structure. This makes it suitable to different types of applications also besides fintech and crypto currency.

The blockchain benefits

I can think of three immediate financial benefits for businesses when blockchain-based solutions are properly implemented. To start with, I’d say protection of Intellectual Property. As is well known, digital information can be infinitely reproduced and distributed widely because of the internet. This has given web users globally a goldmine of free content. However, copyright holders have not been so happy, losing control over their intellectual property and suffering financial loss. Smart contracts in a blockchain network can protect copyright and automate the sale of creative works online, eliminating the risk of file copying and redistribution.
Another intrinsic benefit of smart contracts and the immutability of blockchain networks is in the opportunity to reduce cost and time related to payment disputes, by allowing involved parties to agree contracts that force them to move through a certain checklist before being paid. The most important thing blockchain will do in such a situation is ensure that all parties to a transaction are in agreement with one another about its status and their obligations.

Lastly, and probably less obvious, is the possibility to have a distributed file storage. Decentralizing file storage on the internet brings clear benefits because distributing data throughout the network protects files from getting hacked or lost. Have a look at the Inter Planetary File System (ipfs.io), which makes it easy to conceptualize how a distributed web might operate. Similar to the way BitTorrent moves data around the internet, IPFS gets rid of the need for centralized client-server relationships (i.e., the current web). An internet made up of completely decentralized websites has the potential to speed up file transfer and streaming times.

The blockchain mistakes

Blockchain-based ledgers are less efficient than existing databases, if applied to the wrong context. When someone says they are running something “on a blockchain” what they usually mean is that they are running one instance of a software application that is replicated across many other devices. The required storage space and computational power is substantially greater, and the latency higher, than in the case of a centralized application. Blockchains that incorporate “proof-of-stake” or “zero-knowledge” technologies require all transactions to be verified cryptographically, which slows them down. Blockchains that use “proof-of-work,” as many popular cryptocurrencies do, raise yet another problem: they require a huge amount of energy to secure them. So, what are we doing wrong? First of all, blockchain technology is still in its infancy, comparable to the internet of 20 years ago. Low speed, huge costs. But a great potential.

Before starting a new blockchain project, always ask yourself the following questions, which can determine if blockchain is appropriate for your business scenario: Do multiple parties share data? Is there a requirement for verification of information? Can intermediaries be removed and reduce cost and complexity? If you answered yes to all of these questions, then you have a potential scenario to apply blockchain. Otherwise, probably blockchain is not the best technology to use in this case.

Blockchain industry adoption

According to market analysts and leading consulting firms, the top five industries that blockchain will likely disrupt by 2020 are financial services, government, real estate, supply chain management, and media distribution. Microsoft has also shared an insight of industries of their customers on Azure that are also experimenting with Blockchain. There are financial services institutions, including insurance companies, travel and transportation, retail, power and utilities, and others.

Financial organizations, for example, can use blockchain to redesign high-cost legacy workflows. This helps reduce infrastructure costs, increase transparency, minimize fraud and improve execution and settlement times. Retail and manufacturing can benefit of an improved supply chain management, smart contract platforms that assess state of goods, and transactions made in digital currency. I can think, also, of industries like healthcare or travel for removing intermediaries and third-party verifiers, protect medical records and, in general, provide fast, security-enhanced and authenticated access to information across organizations and geographies.
The picture below depicts industries investing in blockchain projects, as of end of 2017.

Is blockchain secure?

One of blockchain’s benefits is its inherent resiliency to cyber-attack. While not immune to all forms of cyber risk, blockchain’s unique structure provides cybersecurity capabilities not present in traditional ledgers and other legacy technologies. For example, the distributed architecture of a blockchain increases the resiliency of the overall network from being exposed to compromise from a single access point or point of failure. Consensus mechanisms improve the overall robustness and integrity of shared ledgers, because consensus among network participants is a prerequisite to validating new blocks of data, and mitigates the possibility that a hacker or one or more compromised network participants can corrupt or manipulate the ledger. Blockchains also provide participants with enhanced transparency, making it much more difficult to corrupt transactions through malware or manipulative actions. Finally, blockchains hosted on a cloud platform, such as Microsoft Azure, feature even greater cybersecurity protections due to the platform’s access controls and many other protections.

What’s next

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.