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Blockchain

 

Block Party

Social revolution, technological sensation, new digital world economic order—blockchain technology is more than just Bitcoin and has the potential to fundamentally transform traditional business models. But can it also replace the trust embodied by state authorities and mature institutions?

Text Timour Chafik, Illustration Bratislav Milenkovic

In September 2016, the Irish dairy cooperative Ornua did what it does best: it sold its milk. In this specific case, cheese and butter worth $100,000 USD, to be delivered to the Seychelles Trading Company. It’s hardly worth mentioning, except for the manner in which the agreement was realized. With support from Barclays Bank and Wave, a startup company, the deal was processed using blockchain technology—allegedly the first contract worldwide to do so. Using a special platform, all the commercial and freight documents were made available in a forgery-proof manner within seconds—including the payment.

The Irish dairy industry’s comparatively minor deal is a good example of all the possibilities, hopes and expectations bound up with this key technology. In contrast to long-established, Internet-based transaction platforms, blockchain promises more speed, more security, more decentralization, more anonymity and more transparency. And, in particular, the prospect of bypassing intermediaries and authorities to do business directly. For some, this is tantamount to a revolution in which the “data monarchy” of central servers is overthrown and a “data democracy” proclaimed. Others, such as the analyst and economist Anton Golub, view it as nothing less than “the greatest discovery of our lifetime.”

An Excel Worksheet that Grows

A simple Excel worksheet is all that is needed to understand what a blockchain is and can do. All the data is stored there, including monetary transactions, identities and proof of ownership. What distinguishes the blockchain from Excel, however, is that the blockchain’s worksheet cannot be changed later, is encrypted and is maintained not just by one person but by many people—a network that regularly agrees on the correct status of the worksheet and follows clearly defined guidelines. These rules are known to everyone and can only be changed if the majority wants them to be. Anyone who violates the rules is kicked out.

Now the worksheet, which is also known as “distributed ledger technology” (DLT) or a “shared ledger,” is growing. Further transactions are entered as new items in the shared ledger. However, since this is a thousandfold copy distributed worldwide on computers, instead of being kept in a desk drawer somewhere, any new transaction also appears in all other ledgers and is authenticated by the computers participating in the network. Only then are the entry and transaction valid. This can’t go on indefinitely; when the ledger reaches a certain size it is closed. A complete block has been created, a new one is started—and a chain of blocks, the blockchain, grows.

The essence of the blockchain shines through, even in this short description: there is no single, overriding authority that keeps everything orderly. It is the decentralization, the mass of network computers, the transparency paired with cryptographic encryption mechanisms, that regulate and control: “The protocol coordinates people who do not know and do not trust each other, across national borders and without traditional, centralized institutions or legal agreements,” says Shermin Voshmgir, director of the interdisciplinary Research Institute for Cryptoeconomics at Vienna University of Economics and Business. “The rules of the game are regulated in the code, have economic incentives and are automatically executed by smart contracts through a distributed computer network.” This enables a new kind of economy where anyone can join without the permission of a central authority, such as a bank: “Anyone can open an account and—at least theoretically—mine crypto-­ currencies such as Bitcoin.”

 

 

Game Incentives for Correct Behavior

But how do you get a widely dispersed group of people in a virtual global network to trust each other and follow the rules of the game? “By providing incentives for ‘correct’ behavior,” Voshmgir says. “Encryption provides the necessary transparency, but also the necessary privacy for all network actors. Game-theory incentive mechanisms should guarantee the security of distributed systems.” The mining of Bitcoins, for example, is ultimately nothing more than an incentive to verify transactions.

Anyone who listens to Voshmgir, reads her many publications on the subject or attends her lectures will notice her enthusiasm about this key technology’s enormous transformation potential. But she is also naturally well aware that cryptoeconomics based on blockchain technology is still in its infancy. “It’s still being tinkered with all over the place,” Voshmgir says. In the ups and downs of this grandiose technological experiment—the redefining of economic principles and economic psychology—it is hardly surprising that things haven’t completely settled down yet. The volatility of various cryptocurrencies, Bitcoin in particular, demonstrates what these oscillations can look like. The dinosaur among the digital currencies has decreased in value many times over compared to 2017, but its exchange rate has still increased by a factor of 25 as compared to 2015. Predictions about where the price could be at the end of 2018 vary from “will have disappeared by then” to “may have crossed the one-million mark.” Serious and secure this is not.

Actually the question is not so much where Bitcoin and the rest will rank in the exchange rates, but whether they will exist at all. Other cryptocurrencies have appeared in the meantime, including IOTA or Hedera Hashgraph, based on the blockchain idea but using alternative economic incentive mechanisms. Some people find the whole field difficult to follow, despite their best efforts: the “Global Blockchain Benchmarking Study,” published by the Cambridge Centre for Alternative Finance in autumn 2017, worked with data from more than 200 companies, DLT startups, central banks and public institutions in 49 countries. One of the study’s co-authors, Hamish Thomas, a partner in EY Financial Services, says straightaway, “Central banks are also increasingly conducting research in the area of digital currencies; more than 80 percent of the 57 central banks surveyed say that they are addressing this issue. Meanwhile, these institutions definitely see the potential of using DLT to reduce transaction, settlement and reconciliation costs or to upgrade their infrastructure with collaborative, interoperable systems and platforms.”

A Little Bit of a Revolution

This approach is of interest to other industries beyond just financial and banking sectors: for insurance companies and public authorities that archive, verify, patent or make information available and also for logistics and the sharing economy. As described in the paper “Blockchains, Smart Contracts and the Decentralized Web,” published in German by the Technology Foundation Berlin, blockchain-based processes with a peer-to-peer processing system have the potential to replace the services currently offered by platform operators: “Thus the need for a platform operator—at least in the conventional sense—would be eliminated or at the very least greatly changed.” In other words: Blockchain is like Uber or Airbnb—but without Uber or Airbnb.

This may sound appealing in the sharing economy, but for institutions such as central banks it is far too decentralized. Answering the question as to what would change with the use of blockchains, Deutsche Bank responded that decentralized infrastructures could certainly be used, “but with responsible authorities to ensure that certain regulations are being followed.” So instead of a total reorganization of the economic balance of power, it would be just a little bit of a revolution, a little decentralization and a little less intermediating and controlling institution?

“In fact, blockchain’s unique selling point—the secure, transparent, non-manipulable storage of data records—is subject to negotiation for each individual case,” says TÜV SÜD Strategic Business Development Manager Alexander Stadelmann. “A blockchain can be stored decentrally on distributed computers, as for instance it is for cryptocurrencies. This can prevent a blockchain from being tampered with; for closed blockchains, this decentralization may be limited, but it is still based on the principles of the original blockchain.”

 

 

Efficiency-Enhancing Operating System

Stadelmann views the traceability of food as a realistic approach for distributed ledger technology: “For food, it is important that the entire supply chain is completely traceable from end to end, and it could be made even more secure with blockchain. We’re working on this right now because we think of this key technology as an additional, efficiency-enhancing tool.” Using it, all the information—from the farmer in livestock production to the supermarket that sells the steaks—could be encrypted, stored in the network and then viewed by authorized users. “This presents a huge advantage, especially for large retailers, because if there’s a recall, traceability could be guaranteed much more quickly, more securely and more cost-effectively,” Stadelmann says.

In this case, blockchain’s value is found above all in linking a wide variety of parties involved in buying and selling in a secure, trustworthy platform. “Blockchain is the operating system that creates the same reality for all participants,” says Wolfgang Lehmacher, director and head of supply chain and transport industries at the World Economic Forum. “But this should be understood as going well beyond the traditional concept of supply chains and instead under the term ecosystem, incorporating networking with cities, authorities and governments as well.” It’s an idea that can be contemplated beyond the noisy, colorful world of cryptocurrencies and that reveals: the technology is more a tool than a gimmick, more an optimization of accounting processes than a “pump and dump.” Taking a closer look, there seems to be more solid block behind the hype after all.