Blockchain, despite initial anticipation, has not quite lived up to its game-changing potential. The key to unlocking its value lies in leveraging the technology only when it offers the simplest and most effective solution possible.
Over the past few years, there has been a widespread chorus praising blockchain as a groundbreaking technological revolution for businesses. Since its inception nine years ago, companies, regulators, and financial technologists have invested significant time and effort in unraveling its immense potential. The outcomes of their relentless exploration have begun to reshape fundamental aspects of business operations, notably in the domains of accounting and transactions.
In the midst of fervent experimentation, various industries, spanning from financial services to healthcare and the arts, have discovered and documented over 100 distinct use cases for blockchain. These encompass a wide spectrum, ranging from innovative land registries to Know Your Customer (KYC) applications, as well as smart contracts that facilitate a multitude of actions, such as product processing and share trading. Among the remarkable outcomes observed thus far, blockchain technology has proven its prowess in securely storing information, eliminating intermediaries, and fostering enhanced collaboration between companies, especially in areas pertaining to data standards.
One indication of the perceived potential of blockchain is the substantial investments being made. In 2017 alone, venture-capital funding for blockchain startups reached an impressive $1 billion. Noteworthy players like IBM have also made significant financial commitments, with over $200 million invested in a blockchain-powered data-sharing solution for the Internet of Things, while reports suggest that Google has been actively engaged with blockchain technology since 2016. Furthermore, the financial industry dedicates approximately $1.7 billion annually to experimentation in this field.
There is a clear consensus that blockchain holds the promise of being a game-changer. However, doubts are beginning to emerge. Particularly concerning is the fact that, despite the considerable amounts of money and time invested, tangible outcomes have been relatively limited. Many of the proposed use cases remain in the conceptual stage, with a significant number still under development but lacking concrete outputs. In essence, despite the billions of dollars poured into investments and the abundance of media attention, the evidence supporting practical and scalable applications of blockchain technology remains scarce.
Infant technology
Looking at it from an economic theory standpoint, the somewhat faltering trajectory of blockchain development is not entirely unexpected. After all, it is a nascent technology that exhibits characteristics of instability, high costs, and complexity. Moreover, it operates in an environment that lacks comprehensive regulation and is marred by selective distrust. According to classic lifecycle theory, the evolution of any industry or product can be segmented into four distinct stages: pioneering, growth, maturity, and decline. The first stage represents the initial phase where the industry or a specific product is introduced to the market, often ahead of proven demand and without undergoing thorough technological testing. During this stage, sales volumes are typically low, and return on investment remains negative. The second stage marks the point at which demand begins to gain momentum, the market expands, and the industry or product experiences significant growth and acceptance.
When considering its various applications, blockchain seems to be largely confined to the initial stage of the industry lifecycle, with a few exceptions. The majority of proofs of concept (POCs) remain in the pioneering phase or have been discontinued, and many projects have failed to progress beyond Series C funding rounds.
One of the reasons for this lack of progress is the emergence of competing technologies. In the realm of payments, for instance, it is logical to explore how a shared ledger could potentially replace the existing highly intermediated system. However, blockchain is not the sole contender in this space. Numerous fintech companies are disrupting the payment value chain. Out of the nearly $12 billion invested in US fintech last year, 60 percent was focused on payments and lending. Meanwhile, SWIFT's global payments innovation initiative (GPI) is addressing initial pain points through enhanced transaction speeds and improved transparency by leveraging collaborative efforts among banks.
Blockchain players in the payments sector, like Ripple, are increasingly forming partnerships with nonbank payment providers whose business models align better with blockchain technology. These companies may also be more inclined to swiftly integrate and adopt the technology.
Additionally, the payments industry faces a classic innovator's dilemma: incumbents are aware that investing in disruptive technologies, and the subsequent rise in customer expectations for faster, easier, and cheaper services, may lead to cannibalization of their own revenues.
Considering the range of alternative payment solutions available and the disincentives for incumbents to invest, the pertinent question is not whether blockchain technology can offer an alternative, but rather whether it is necessary to do so. Occam's razor, a problem-solving principle, suggests that the simplest solution is often the best. Based on this premise, blockchain applications in the payments sector may not necessarily be the optimal answer.
Industry caution
The industry is gradually becoming aware of this dilemma. In the early stages of blockchain development, the financial services sector took the lead, allocating significant resources between 2012 and 2015 to streamline processes. Banks and other financial institutions identified areas such as trade finance, derivatives netting and processing, compliance, and payments as key targets for improvement. Many companies established innovation labs, recruited blockchain experts, and invested in start-ups and collaborative ventures. A prominent industry consortium managed to attract over 200 financial institutions to its ecosystem, aiming to deliver the next generation of blockchain technology specifically for finance.
As financial services paved the way, other sectors followed suit. Insurers recognized the potential for enhanced contracts and guarantee efficiency, as well as the opportunity to share intelligence on underwriting and fraud. The public sector explored ways to update its sprawling networks, seeking to create more transparent and accessible public records. Automakers envisioned smart contracts built upon the blockchain to automate leasing and rental agreements. Meanwhile, various entities identified prospects for modernizing accounting practices, contracting systems, fractional ownership models, and achieving operational efficiencies in data management and supply chains.
By the conclusion of 2016, the future of blockchain seemed exceedingly promising. Investments were skyrocketing, and some of the structural hurdles that plagued the industry seemed to be subsiding. Technical issues were being addressed, and new iterations of the ledger were introduced, offering enhanced privacy features to cater to the needs of businesses. Regulators also displayed a more optimistic stance, focusing on fostering communication, adaptation, and open discussion rather than obstructing progress.
However, when viewed through the lens of industry lifecycle, a more intricate dynamic began to emerge. Just as the financial services sector's investments in blockchain were approaching the end of Stage 1—typically the juncture where they should be poised for growth—progress appeared to stumble.
Emerging doubts
McKinsey's collaboration with leaders in the financial services sector over the past couple of years has revealed a growing skepticism among those directly involved in blockchain development. Interestingly, while other industries were gearing up and making progress, a sense of caution permeated certain levels of the financial services industry (despite confident statements from senior executives). The hard truth was that despite billions of dollars being invested, very few use cases demonstrated technological, commercial, and strategic viability or the ability to scale effectively.
By late 2017, many professionals working in financial institutions began to perceive blockchain technology as either too immature, unsuitable for enterprise-level applications, or simply unnecessary. Numerous proof of concepts (POCs) offered limited benefits, often failing to surpass the capabilities of existing cloud solutions and sometimes raising more questions than answers. Moreover, doubts arose regarding the commercial viability of blockchain, as tangible cost savings or incremental revenues remained elusive.
Another concern revolved around the need for a dedicated network. Blockchain's fundamental premise is the sharing of information, which necessitates cooperation among companies and substantial efforts to standardize data and systems. However, the coopetition paradox hindered progress, as few companies were willing to spearhead the development of a utility that would benefit the entire industry. Additionally, many banks were preoccupied with broader IT transformations, leaving little room to champion a blockchain revolution.
The crucial question now is whether these doubts still hold merit or if the slower-than-expected progress in blockchain development is the primary cause. In recent months, several financial institutions have begun to reassess their blockchain strategies. They are subjecting POCs to more rigorous scrutiny and adopting a more focused approach to development funding. Many have narrowed their focus from numerous use cases to one or two, intensifying their oversight of governance and compliance, data standards, and network adoption. Several consortia have reduced their proof of concept portfolios from dozens in 2016 to just a handful today.
The emergence of cryptocurrencies, particularly Bitcoin, as potential mainstream financial instruments prompted the financial services industry to take the lead in blockchain experimentation, positioning them 18 to 24 months ahead of other sectors in the industry lifecycle. Given this time gap, it is unsurprising that the initial concerns expressed in banking are now surfacing in other industries, eroding the initial enthusiasm and giving rise to a sense of underachievement.
In reality, rather than following the conventional upward trajectory of the industry lifecycle, blockchain seems to have reached a plateau in the bottom left-hand corner of the X-Y graph. For many, the anticipated Stage 2 growth is yet to materialize. As we step into 2019, the practical value of blockchain technology primarily resides in three specific areas.
- Niche applications: Blockchain technology possesses inherent strengths that make it ideally suited for certain specific use cases. These scenarios often involve aspects of data integration, such as monitoring asset ownership and status. Notable examples can be found in industries such as insurance, supply chains, and capital markets, where distributed ledgers can effectively address issues such as inefficiency, lack of transparency, and fraudulent activities.
- Value in modernization: Industries with a strategic focus on modernization are drawn to the blockchain as a valuable tool to advance their goals of digitization, streamlined processes, and enhanced collaboration. Notably, sectors like global shipping contracts, trade finance, and payments have experienced a resurgence of interest with the advent of blockchain technology. However, it is important to recognize that in many cases, blockchain is just a component within a larger solution and may not necessarily entail a fully decentralized ledger. In certain instances, renewed efforts, investments, and industry collaboration are effectively overcoming challenges, regardless of the specific technology employed.
- Value in reputation: An increasing number of companies are embarking on blockchain pilots to enhance their reputation, showcasing their innovative capabilities to shareholders and competitors. However, it's important to note that these initiatives often lack the intention of developing a commercially viable application at scale. Examples of such blockchain endeavors can be observed in areas like customer loyalty programs, IoT networking, and voting systems. In this context, claims of being "blockchain enabled" may ring hollow, as the true impact and implementation of blockchain technology may be limited or inconsequential.
A future for blockchain?
Considering the lack of compelling use cases at scale and the apparent stagnant position in the industry lifecycle, it is only natural to raise questions about the future of blockchain. Will it truly revolutionize transaction processing, leading to substantial cost reductions and efficiency gains? Are there tangible benefits that justify the significant changes required in market infrastructure and data governance? Or is a secure distributed ledger merely one option among many when contemplating the replacement of legacy systems?
Undoubtedly, there is a growing perception that blockchain is a solution in search of a problem, with a level of complexity that hinders its widespread understanding and adoption. This perspective is further amplified by short-term financial pressures, resistance from certain quarters due to potential job displacement, and concerns about disrupting existing revenue streams. Governance poses challenges as well since making decisions in a decentralized environment is inherently complex, particularly when accountability is distributed across multiple entities. Additionally, there are technical hurdles to overcome, such as limitations in data storage capacity within blockchains.
The anticipated rise of over 20 billion connected devices by 2020 necessitates efficient management, storage, and retrieval of data. However, current blockchain architectures prove inefficient for data storage due to the requirement for every node in a network to process every transaction and maintain a complete copy of the entire system state. As a result, the transaction volume is limited by the capacity of individual nodes, and the responsiveness of blockchains decreases with the addition of more nodes, introducing latency issues.
Security concerns also arise within blockchain systems. In smaller networks where validation relies on a majority vote, there is a notable potential for fraudulent activities, known as the "51 percent problem." Furthermore, advancements in quantum computing pose a future security challenge. In 2016, Google reported that its quantum prototype was significantly faster than any existing computer in its lab, raising the possibility of quantum computers being capable of compromising the cryptographic codes used to authorize cryptocurrency transactions. This is particularly alarming for a network that claims to be resistant to fraud.
Nevertheless, there is still hope. Many of the validation protocols in use today are expected to be upgraded or replaced in the next few years, and innovators are already working on solutions. For instance, Cardano represents a third-generation blockchain technology, leveraging peer-reviewed open source code and designed to be resistant to quantum computing. Private blockchains are also being developed to provide network participants with control over access to the ledger and the connections between nodes.
Furthermore, promising advancements have been made in use cases outside of the financial industry. Recent experiments in supply chains, identity management, and the sharing of public records have shown positive results. Grocery stores, for instance, have explored blockchain-enabled products and services to target customers, while shipping executives have launched real-time registries of containers underpinned by blockchain technology.
An emerging perspective suggests that blockchain's most valuable applications lie in democratizing data access, fostering collaboration, and addressing specific pain points. It proves beneficial when shifting ownership from corporations to consumers, facilitating vertical sharing of supply chain provenance, and enabling transparency and automation. It is likely that these types of use cases, rather than those primarily focused on financial services, will ultimately demonstrate the greatest value of blockchain technology.
Moving through the cycle: Three key principles
The transition of any blockchain application to the second stage of the industry lifecycle is far from guaranteed. It necessitates a compelling rationale, substantial capital investment, and enhanced standardization. Fintech leaders must adopt a more nuanced perspective of their respective industries and ensure they have the right expertise within their teams. Nevertheless, when there is a genuine potential to address widespread pain points, the opportunity for progress remains.
In order to advance towards that goal, we identify three fundamental principles as minimum requirements for making significant headway:
- To make meaningful progress, organizations must begin by identifying a genuine problem. Without a valid problem or pain point, blockchain is unlikely to provide a practical solution. It's important to remember the principle of Occam's razor, which suggests that the simplest solution is often the best one. Therefore, companies should thoroughly assess their risk-reward appetite, level of knowledge and understanding, and potential benefits. They should also carefully evaluate the potential impact of any project and ensure it aligns with a solid business case.
- For progress to be made, it is crucial for organizations to establish a clear business case and target return on investment (ROI). They need to identify a compelling rationale for investing in blockchain that aligns with their market position. This decision should be supported at the board level and embraced by employees, without concerns about cannibalizing existing operations. Pragmatic considerations must be taken into account, such as the organization's ability to shape ecosystems, establish standards, and overcome regulatory obstacles. Recognizing the value of network effects, it is essential to ensure that a majority of stakeholders are aligned with the blockchain initiative. To facilitate smooth operation, a comprehensive governance agreement should be put in place, covering aspects such as participation, ownership, maintenance, compliance, and data standards. Moreover, securing adequate financing from the outset, with commitments in place until commercial launch, is crucial for success.
- Companies must agree to a mandate and commit to a path towards adoption. Once a use case is chosen, they must assess their ability to deliver, ensuring sufficient economic and technological support. If they pass these hurdles, the next step is to launch a design process and gather essential elements such as the core blockchain platform and hardware. Performance targets, including transaction volume and velocity, should be set. Simultaneously, companies should establish organizational frameworks, including working groups and communication protocols, to support development, configuration, integration, production, and marketing for scaled adoption.
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