For several years, Bitcoin has captured headlines not only for becoming the leading digital currency, but also for wild fluctuations in its value. Will Bitcoin succeed? The jury’s still out. But now the underlying technology – an encrypted, distributed digital ledger called blockchain – is riding a wave of adoption for many new use cases.
What is Blockchain?
Developed by the founders of Bitcoin, blockchain is an open source peer-to-peer system that allows users to transact directly using digital assets and without an intermediary. The transactions are verified by network nodes and recorded in an encrypted public distributed ledger called the blockchain.
Blockchains have two essential ingredients:
Encryption. A record of each transaction is contained in segments of data – or blocks – linked together in a chain that represent the transaction. Each block is encrypted by altering, or hashing, part of the previous block. This cryptographic connection between each block and the next forms the links of the chain. The algorithms include an ID for each buyer and seller in a transaction, and those IDs become part of the block under construction. Each added link to the chain compounds the mathematical difficulty of committing a hack or fraud because each block is encrypted and validated.
Public ledger.The chain essentially becomes a distributed database, shared by all network participants, with entries made automatically each time a block is created. The ledger stores basic transaction activity –sender, receiver, time, asset type, quantity, etc. It is updated using a process in which the users’ computers confirm and validate time-stamped additions to the database with each other as the transaction occurs.
Markets for Blockchain
Blockchain can secure any digital transaction, not just payments, and the race is on to identify, develop – and invest in – use cases outside the Bitcoin ecosystem. In 2016, many adopters of other use cases, especially in financial services, will move from prototype to production, and analysts expect an infusion of investment in non-Bitcoin blockchain.
Banks and other financial institutions lead the way in non-Bitcoin projects, but blockchain has broad potential to transform how business, government and individuals conduct any kind of digital business. Whether b2b, b2c or p2p, any digital transaction requiring validation by a middleman and any digital network requiring oversight by a central administrator are ripe for blockchain disruption – ecommerce, music distribution, real estate, event tickets, gift cards, voting, securities trading, supply chains, auditing, and contracts to name a few. Communication and transactions on the Internet of Things is also a blockchain candidate,with IBM planting its flag in this use case more than a year ago.
Investments in Blockchain
By the end of 2015, nearly 200 venture capital firms had invested just under $1 billion, including $468 million in 2015, in Bitcoin and blockchain startups. Khosla Ventures, AME Cloud Ventures, Lightspeed Venture Partners, and Andreessen Horowitz are among the many investors. The lion share of funding has gone to the Bitcoin ecosystem.
“In the early days of blockchain technology, many blockchain companies focused solely on (Bitcoin) payment processing and exchange trading,” according to the Blockchain Technologies website, which tracks investments. “As the wider scale of blockchain technology started to become more apparent, new blockchain companies started to emerge with use cases in industries other than just finance.”
In an analysis released in December 2015, Magister Advisors, a boutique investment bank based in London and San Francisco, asserts that blockchain is now on a trajectory separate from Bitcoin. Magister based its conclusions on interviews with 21 Bitcoin startups and 12 blockchain startups outside Bitcoin. The 33 startups received 51 percent of total global funding for this technology as of the end of 2015. The analysts also interviewed several hedge funds, investment banks and other financial institutions that are investing in blockchain projects and startups.
“The Bitcoin and blockchain markets have fundamentally diverged over the past 12 months,” the Magister analysts conclude. They believe the next infusion of funding will be for non-Bitcoin projects. “We estimate over $1 billion will be spent by large financial institutions on [non-Bitcoin] blockchain over the next 24 months.”
According to the Magister report, banks are using blockchain in areas requiring a distributed ledger with cryptographic integrity; as a potential replacement for middleware networks and clearinghouses in financial transactions where third party verification is required, and in applications extended to other networks where veracity is critical to performance. Large financial institutions typically have identified 10 to 20 potential blockchain projects to evaluate and 2016 marks a “race to production” as innovators seek to push beyond the prototype stage, Magister adds.
Impact of Blockchain
Blockchain is likely to save financial institutions tens of billions of dollars just on infrastructure costs. The Magister analysis cites The Fintech 2.0 Paper: Rebooting Financial Services as estimating “that distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading, and regulatory compliance by between $15-20 billion per annum by 2022.”
Several blockchain consortia have formed, including the Hyperledger initiative led by the Linux Foundation. The Hyperledger’s many members include IBM, Intel, Cisco, Fujitsu and others.
Many anticipate blockchain will have a dramatic impact on accounting and audit services in the future, with the automated encrypted ledger replacing many manual processes. With blockchain, every single transaction could be audited automatically.
While most non-Bitcoin innovation with blockchain is taking place in financial services, some startups are focused on areas entirely outside cryptocurrency and financial services.
The list on the Blockchain Technologies site includes startups pursuing an array of other use cases: peer-to-peer markets or open bazaars; real estate title registry; board of directors governance; managing for-profit and non-profit virtual organizations; crowdfunding without central administration (appropriately, already used by some blockchain startups); insurance; real estate; supply chain transactions, and selling or trading any digital asset, including images, videos, audio files and decentralized applications and other computer code.
These areas are already under development. Just one blockchain startup, Ethereum, is involved in numerous non-financial projects. They include online code compiling, a board governance app, enterprise applications, and smart contract apps and tools.
Smart contracts are an early popular use case. Blockchain can be used to facilitate, verify, or enforce the negotiation or performance of a contract, some of whose clauses could be self-executing and self-enforcing in the digital space, thus reducing legal and transactional costs associated with traditional contracts.
Whether Bitcoin replaces hard currency fully or in part remains an open question. Supporters and skeptics make solid arguments both pro and con. But whatever the future holds for this cryptocurrency, it seems clear that as early disruptions from blockchain technology start taking shape, the field of potential use cases for this innovative technology will expand further.
Raman Chitkara leads the global technology practice at PwC.He has more than 30 years of experience working in the technology industry in the Silicon Valley. His clients have included technology companies with global operations ranging from start-ups to multibillion-dollar multinationals in semiconductor, software, internet, computing and networking sectors.Read his full biography here.