Much has been made of the potential of bitcoin, the currency, but the venture capital community is increasingly focusing on the commercial potential of the underlying blockchain technology. Perhaps more interestingly, executives at large and sophisticated incumbent financial institutions and financial technology companies that I have spoken to, by and large, do not dismiss the technology. They believe it has legs and are studying the technology with a goal to enhance their product offerings. In short, many incumbents have a blockchain strategy. The general spirit is that the blockchain is like the Internet; sure, some businesses were disrupted and rendered obsolete, but the Internet made most financial services and other industry products better.
While many questions remain, the blockchain’s core features – decentralization, speed, low take rates, and stability (i.e. hard to hack) – allow it the potential to reinvent many industries. Beyond banking and payments processing, there are fascinating commercial applications to capital markets, insurance, legal technology, advertising, and government, among others. In each industry, there is the potential for significant efficiency gains (i.e. current functionality delivered faster and more cheaply) but also disruption. What follows in this piece is a synthesis, in simple language, of some of the most exciting commercial applications of blockchain technology we may see across these major industries in the future.
Banking and Payments Processing
Disruption in payments processing is the most obvious application of the Bitcoin blockchain. There are currently over 80,000 merchants globally that accept bitcoin as a form of payment (including Expedia, Dell, Dish Network, and Overstock) and the underlying technology can be used to accept payment in any currency. The blockchain can also be used for B2B payments.
Faster and cheaper payments
The primary benefit of payments using the blockchain is to reduce the time to settlement and costs of intermediation. Settlement has the potential to be reduced from three (or more) days currently to less than one hour using the blockchain, where transaction verification is near real-time. On the cost side, the current payments value chain is complex, with many sub components of the so-called merchant discount (the difference between what a customer pays for a product and what the merchant actually gets), which averages around 3% for online transactions. Merchant acquirers, acquiring banks, issuing banks, payment processors, and card networks all take their share of the merchant discount cut.
The cost of purchasing a product with bitcoin, on the other hand, is currently around 1%. Although the costs may eventually rise, analysts estimate that the blockchain, using current processing volume, can save over $100 billion annually relative to traditional payment infrastructure. This represents a take rate that can be recouped by merchants. Better still, there is some evidence to suggest that the savings will be passed on to consumers. Dell, for instance, provides a discount to customers paying with bitcoin since it is cheaper for them to process.
The most dramatic example of the cost and time savings within the payments industry is international remittance. Here, the cost could be reduced from 10% (or more) to 1% with settlement from five days to 10 minutes. With almost half a trillion dollars of remittance sent to the developing world each year, this is a massive opportunity for the blockchain to reduce tens of billions of dollars of fee leakage to the benefit of a demographic of people that could really use the capital.
It is very hard to initiate fraudulent transactions on the blockchain. Unlike with traditional payments, payers do not need to expose their actual payments credentials but just their public key. This therefore obviates hacks such as we have seen with Home Depot, TJ Max, Target where credit card payment data was stolen.
There is also no fraud in the form of chargeback risk for merchants (on average about 30 basis points loss on gross dollar volume) since transactions on the blockchain are irreversible. Customers, in turn, can be protected via standard escrow arrangements.
Unlike with traditional payments infrastructure, there are no base or minimum fees for payment using the blockchain. This allows for very small payments – smaller than a single cent – that are currently not economically feasible.
The ability to make micropayments allows for some powerful applications. Content unbundling and monetization is one such example, where consumers of content can dynamically pay for content on a highly granular basis. This could mean giving consumers the option to surf the web without advertising or can allow content creators to earn greater yield by selling their content piecemeal rather than as a more blunt packaged subscription. The technology can also be used to prevent spam and DDoS attacks. A micro charge on every email sent would be immaterial for a legitimate email user but would be cost prohibitive for spammers who send billions of emails.
Promoting new ways to access capital via peer-to-peer infrastructure
More generally, the blockchain will impact the banking industry by more effectively enabling peer-to-peer activity through its distributed structure. The blockchain can be the underlying operating system for the P2P lending industry. This could disrupt, by disintermediation, consumer, commercial, mortgage and student lending. It could also disrupt the way capital is raised by improving the crowd funding mechanism by allowing for peer-to-peer assurance contracts based on the Bitcoin protocol. Clearly, these are already happening without the blockchain, but it can be made more efficient.
Blockchain as Policy Administration System
It may one day be possible for the blockchain ledger to function as an insurance carrier’s core policy administration system. One could imagine a more streamlined onboarding and digital authentication workflow where policy agreements are signed into the blockchain and enforced. Smart contracts based on the blockchain could also allow insured parties to self-administer their policies and carriers to more dynamically underwrite, adjusting coverage and pricing in real-time.
Blockchain technology could also function as the backbone of a peer-to-peer insurance platform. This could work well for common risks where the insured amount is fully or even partially funded. Certain lines of indemnity insurance, such as in the shipping industry, for example, where an association of ship owners and operators effectively insure each other, might one day be amenable to using the blockchain to be its enforcement mechanism.
More generally, the technology might also enable the formation of blockchain-based mutuals. Capital could be pooled from all policyholders and algorithmically run at a break-even basis with minimal overhead and no profit motive, effectively disintermediating traditional insurance.
Even more extreme than mutuals (which are owned by customers) would be enterprises not owned by anyone – so-called decentralized autonomous organizations – delivering insurance coverage with the cheapest possible premiums.
Disrupting title insurance
Within the insurance industry, title insurance deserves a special call out. If ever there was a business ripe for disruption, title insurance is it. My wife and I refinanced the mortgage in our last house three times (rates kept dropping), and we had to pay several thousand dollars of title insurance each time. It just makes no sense.
Instead of this antiquated and expensive system, it may be possible for proof of title to be established by being written into the blockchain. Once written into the blockchain, which is effectively a large database, it cannot be altered. Once established, title can be confirmed (by a mortgage or auto lender for instance) and also transferred to a potential buyer of the property.
The most sophisticated market structure companies are seriously studying and investing in blockchain technology. JP Morgan Chase’s CEO Jamie Dimon said in a recent letter to shareholders that “Silicon Valley is coming” and that they are studying competing technology in excruciating detail. Goldman Sachs also invested in Circle, while the ICE invested in Coinbase. Most recently, the Nasdaq has started experimenting with blockchain technology to automate trading of private shares.
Simplifying back office processing
In the capital markets arena, blockchain technology has the potential to simplify back office processing for the financial services industry by making the execution, clearing, and settlement of securities faster and cheaper. Ownership of not only currency, but also equities, fixed income securities, commodities, and associated derivatives can be traded in a decentralized fashion directly between end parties.
A decentralized ledger obviates the need for transactions to be filtered through middlemen including centralized exchanges, clearinghouses, and banks. This could enable near immediate settlement (versus T+3 which is the norm today). Faster settlement would bring a myriad of benefits including reducing counterparty risk and allowing financial and corporate trading firms to more efficiently use their capital.
Sophisticated trading applications
The technology also allows the possibility of programming custom logic into the blockchain to enable conditional asset transfers. In addition to allowing for more sophisticated program trading, one could also imagine creating custom logic that would allow a firm to automatically pre-clear trades with its compliance protocols or even automatically send a percentage of the trading profits to the IRS.
The pseudonymous nature of the blockchain also has potential applications to trading where holders of large positions in certain securities might dribble out their position with less price impact than when the seller is known (without having to trade on so-called dark pools).
Margin trading (and collateralized lending for that matter) can also be improved; a trading entity’s unencumbered ownership of certain assets can be verified in the blockchain. Trading disputes can also be reduced. In the credit default swap market, for example, before the trade is in place, counterparties can agree exactly to what constitutes a default. This would remove the need for human judgment, ambiguity, and action after the fact.
A consolidated audit trail
The regulatory compliance function also has the potential to be dramatically improved by what is effectively a consolidated audit trail of every transaction in the blockchain. While transactions in the blockchain are done under pseudonyms, the SEC could be given access to the underlying identity and could use the trading data to dramatically improve its triangulation techniques for insider trading or AML activities, for example. Additionally, the compliance and risk management departments of broker dealers and hedge funds could use the technology to automatically block trades of securities either on their restricted trading lists or when certain risk exposure thresholds are breached.
Smart contracts based on the blockchain have the potential to impact the legal industry by establishing agreements between parties digitally, verifying ownership of digital and real property at a point in time, as well as transferring assets based on self-defined and self-executing protocols.
A key feature of the bitcoin blockchain is that it can prove that an agreement existed at a certain point of time by being hashed into the blockchain. This can be used to establish peer-to-peer contracts. If you and your counterparty both sign the contract using your private key, the contract is in force. What is effectively a notarized ledger in the blockchain will track activity in way that is hard to dispute by counterparties. The blockchain could function as a verifiable platform document, execute, view, and transfer contracts across industries. By the way – it also means that we might one day be able to get rid of the antiquated notary public profession.
The blockchain can also be used to timestamp and store work and demonstrate ownership of data without exposing the underlying data. This is useful in the field of intellectual property as well as scientific work. One could not only prove ownership of digital assets but also protect and control the distribution of it. In the scientific research world, scientists could time stamp a document to prove they are the first to have that idea.
Once property is assigned digital ownership, this ownership title can be traded easily. Contracts with self-executing protocols based on pre-defined conditions written into the blockchain can automatically transfer a title when certain events occur.
Dramatically improving estate planning and foreclosure
Estate planning could greatly benefit from this. Wills could be automatically executed with assets transferred as specified by the owner upon death. No probate, no lawyers, no estate administrators, no ambiguity, and no opportunity for interested parties to dispute it. The foreclosure process could also be greatly simplified. If minimum interest and principal payments on mortgages, corporate or consumer debt are not made, then, after the appropriate grace period, title to the underlying property can be transferred to the lender. Liens, escrow arrangements, earnouts, guaranteed bonuses, and the like, can all be enforced with these smart contracts.
The process of voting for elections and referendums can be greatly improved with the blockchain technology. Authorizing one vote per person, or per key, can confirm that the person is authorized to vote.
I believe the blockchain has the potential to dramatically increase voter participation as well. Imagine not having to commute to a high school gym and wait in line when it is raining and you are having a busy day but rather just vote on your mobile phone. There can be an accurate and near real-time vote counting, not to mention less time and expense wastage on manual counting and recounting. This is the future – there may one day be no need to manually count and re-count Presidential election ballots in Florida.
The process of corporate and consumer taxation can also be simplified. Tax fraud, as well as the billions of dollars and hours spent on corporate and consumer tax preparation, could be reduced. Tax liability can be automatically calculated and collected in the blockchain. Sales tax, employee tax withholding, income tax, corporate taxes, capital gains taxes, could all be automated some day.
The blockchain itself is a mesh network (vs. a hub and spoke model) where all nodes connect to other nodes. This would allow a more efficient sharing of resources across a network. It could also be a platform for devices to communicate with one another.
Sharing resources across the network
Digital resources can be allocated to entities through a blockchain-based marketplace. Enterprises could more efficiently operate network IT resources (storage, processing power, bandwidth, energy) across enterprise and networks. If traveling overseas, you can connect to the cheapest Wi-Fi network. If you have excess capacity of some resource you can sell or lease it back to a mesh network.
The mesh network would also make it possible for a blockchain-enabled device to understand what other devices are doing and give instructions or permissions to that other device. This is cheaper and more efficient than having a myriad of household devices operating in the cloud.
A New Analytical Layer
Advanced analytics across industries
As a perpetual datastore recording every transaction conducted on it since its inception, the blockchain can be used to glean valuable analytical insights. Purchase decisions, trading behaviors, pricing, supply and demand balance, and many other data points can be used to perform advanced analytics that have predictive value.
For example, a retailer could tailor his product offering to make a product more useful for the consumer if there was a way to see a comprehensive ledger of transaction data. On the enterprise side, companies can use the data from the blockchain ledger to get a fuller picture of customer activities across the enterprise, which would enable revenue enhancement by more effective pricing across siloes and better cross-selling.
As the writing on this topic becomes more and more specialized and technical, I thought that this primer on the blockchain’s commercial applications and potential impact to major industries would be useful. There are many brilliant entrepreneurs working in this area and their impact has the potential to be far reaching. It will be fascinating to see them turn the technology into commercial reality.
Copyright 2015 Ali Rahimtula. All rights reserved.