How blockchain will transform business

Bitcoin boosters promised that the digital currency would change the world. In a sense, it just might, as the technology underlying it goes mainstream. Ben Judge reports.

Last week, fans of the cryptocurrency bitcoin celebrated a landmark event. On Thursday 2 March, the price of a single bitcoin ($1,268) rose above that of a troy ounce of gold ($1,233) for the first time. In practical terms it doesn't mean much, but it's a potent symbol of the high hopes that bitcoin aficionados have for the digital currency the "new digital gold" supplanting the oldest, most enduring form of money. Bitcoin might even meet some of those hopes, but in many ways it's irrelevant. The most interesting thing about bitcoin isn't the currency, it's the technology it's built on: blockchain.

What is blockchain?

Experts agree that blockchain is going to transform the way we do business in the same way that the internet did 20 years ago. It's no longer a trial technology, it's been proven in the wild, so to speak, and it's coming to a business near you soon. And if the length of the queue to get into this year's Blockchain Expo at London's Olympia was anything to go by, it is rapidly going mainstream.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The concept of blockchain and the hype surrounding it can be a little difficult to grasp. At its most basic level, it is just a database. But it's the way in which it differs from a conventional database that will transform everything from currencies to stock exchanges, supply chains and ledgers of ownership such as land registries to medical records, identity documents, even voting. A traditional database or registry has one master copy that must be updated by a trusted party. When a transaction is performed, all parties must wait until the central database has been updated, which involves a whole host of back-office functions and support staff.

Blockchain is different. It is a "distributed ledger" everyone has a copy, and changes to the database are verified by all the users. This allows for multiple rapid changes to the data that is held in the ledger, without compromising the integrity of the data itself. Each transaction is a "block" that gets added to the chain (hence the name blockchain'). Once a transaction is added, everyone with permission to do so can see it on their copy, and blockchain's cryptographic (encoded) audit trail means that it cannot be changed.

Public versus private blockchains

In its purest form (ie, bitcoin-style), a blockchain is distributed to all parties. This has advantages and disadvantages. Its main advantage is that it is truly democratic; every participant has an identical copy of the ledger, which can be updated either by all participants or by some of them, depending on the ledger's rules. The main disadvantage is scalability: as transactions are added, the database grows. As a result, the computing power needed to add and verify transactions becomes huge.

For example, on the bitcoin network, transactions are added and verified by bitcoin "miners", which receive bitcoins as a reward. The reward for verifying each transaction becomes smaller over time, meaning that more work must be done and hence more power is needed to earn the same amount. Servers the size of warehouses are now needed to compute the algorithms required to process transactions.

As a result, many are located in areas where energy is low in price – China, with its cheap coal, is home to some of the world's largest bitcoin-mining operations. Dutch climate researcher Sebastiaan Deetman estimates that by 2020 the bitcoin network will use "more power than Denmark". According to Forbes, by that point, creating a single bitcoin will consume 5,500 kilowatt-hours of power. That's roughly 20% more than the annual electricity consumption of an average British household.

Consequently, most commercial blockchains are likely to be private, rather than true public ledgers. That is, they will be controlled and updated by one or more trusted parties. In the case of financial institutions, each is likely to have a copy. Everyone with permission will be able to see and add to records on the chain.

Smart contracts

The original blockchain performed simple operations keeping a record of individual bitcoin transactions. But it is the use of "smart contracts" that is key to unlocking blockchain's potential. There is no real agreement as to what a smart contract actually is; what most people do agree on, however, is that smart contracts aren't smart and they aren't contracts.

In one iteration, a smart contract is a computer program that is stored and secured on the blockchain and which can control assets on the blockchain. Smart contracts could be used to carry out transactions between two users, without the need for any middleman. Smart contracts control access to the blockchain's database, or "event log", what changes can be made to the blockchain and who has the right to make or view those changes.Several platforms have sprung up as frameworks for developers to work on.

The Ethereum Project is a platform for blockchain software applications ("apps"), with a particular focus on smart contracts. Hyperledger is an open-source, collaborative venture. Meanwhile, Microsoft Azure allows organisations to experiment in the cloud, aiming to be a platform for "blockchain as a service". Many startups are offering services using these platforms. But it is not just small-scale disruptive startups. Big business particularly financial services is taking blockchain very seriously.

R3, a distributed ledger company, is developing advanced, secure digital ledger systems for financial markets. It leads a consortium of some of the world's biggest financial institutions. It started in September 2015 with nine members, including Barclays, Credit Suisse and JPMorgan but was soon joined by others. At its peak, it had 73 members, including Goldman Sachs, Morgan Stanley, HSBC, Deutsche Bank, Banco Santander and Bank of America. Goldman Sachs, Morgan Stanley and Santander pulled out in November 2016, but others are joining.

Financial services is an obvious area for blockchain applications. Buying and selling any financial asset be it shares, bonds or derivatives can be complicated, costly and time-consuming. The time taken to settle and clear trades can be anything up to three days. Records of who owns what are kept centrally. Decentralised exchanges could change all that. Instead of going via intermediaries such as brokers and clearing houses, securities could be traded directly between buyers and sellers, with the transaction recorded on the blockchain. According to Jackie Range in the Financial Times, the Australian Securities Exchange is to upgrade its systems using blockchain (in partnership with the fintech company Digital Assets Holdings). The UK startup Setl is also working on a blockchain-based securities settlement system with the Australian financial administrator Computershare, says Range. It has also worked with the auditor Deloitte and Metro Bank on trialling a contactless payment card that enables retail payments to be processed and settled almost immediately, says Jemima Kelly on Reuters.

Another area ripe for disruption is foreign-currency exchange. Transferring money abroad via a bank is time-consuming and expensive. Peer-to-peer services are cheaper, but even they tend to use middlemen. BTL, a Toronto-listed blockchain firm with offices in London, has developed a blockchain-based method of transferring money directly between two parties. It is now working with Visa. Using BTL's Interbit settlement platform, Visa hopes to cut costs, time and credit risk by using blockchain and smart contracts to "automate many of the regulation and compliance requirements of domestic and international transfers".

Keeping supply chains secure

Supermarkets, pig farmers and cotton traders are turning to blockchain "to root out fraud", says the FT. In a world where horse meat can be sold as prime beef, knowing where the goods on the supermarket shelves come from, and where they've stopped along the way, matters. The container shipping giant Maersk is experimenting with using blockchain to trace the goods it ships around the world, in partnership with IBM, report Nathaniel Popper and Steve Lohr in The New York Times. Maersk's goal is to replace a mountain of paperwork. As Popper and Lohr point out, "a single container could require stamps and approvals from as many as 30 people, including customs, tax officials and health authorities". That is a recipe for delay and for fraud. "The cost of moving and keeping track of all this paperwork often equals the cost of physically moving the container around the world." Using blockchain means that everyone involved with a container can see it being signed off at each stage of the journey. If it's tampered with, or disputes arise, "everyone could go back to the record and be confident... no one had altered it in the meantime."

State-backed blockchain

Governments, with their vast amounts of records that need to be kept secure, are getting in on the action too. Land registries, tax records, medical records and benefit records could all conceivably be kept more cheaply, efficiently and securely by using a blockchain. The republic of Georgia is piloting a blockchain-based land registry, with the blockchain technology company Bitfury, while the government of Honduras is also looking at blockchain to register land titles in association with Texas-based Factom.

And then there's blockchain's original purpose – currency. If a central bank created its own digital currency (and they are most certainly looking into it, even if only on a theoretical level so far) it would have more control over how money is used. It could direct economic activity into specific areas by manipulating interest rates or even charging negative transaction fees on activity it wanted to promote. It would also know exactly how much money was in circulation and exactly how it was being used. That sounds a little creepy and it's one reason we'll keep hanging onto some gold despite bitcoin's landmark. But expect to hear a lot more about blockchain.