Updated: Jul 24
In this second part of a two-part series, we explore how the progress in private sector blockchain solutions has also served to highlight key challenges that remain to broader implementation, including regulatory frameworks, interoperability, falling investor confidence, and more.
Innovative technologies typically start with a small and highly dedicated number of tech-savvy evangelists, but are often rolled out to great fanfare to a public ill-equipped to grasp their true potential until years after mass adoption. Put another way, the effects of new technologies tend to be overestimated in the short-term, but underestimated over the long-term, as affirmed by Amara's law (Figure 1).
In the case of blockchain, the business world’s realisation that its attributes had major application potential across multiple domains of industry beyond cryptocurrencies, coupled with a turbo-charged Wall Street-esque ICO market, set in motion arguably the largest ever hype campaign for any new technology. However, with the high rates of failure came the realisation that significant numbers of 'projects' were effectively cashing in on the magnetism of the 'blockchain' name to garner investor interest. And while a ‘fail-fast’ philosophy can ultimately lead to a higher pace of technological innovation over the long-term, the low conversion rates for blockchain ventures has largely been the result of their being ill-conceived and poorly understood.
Figure 1: Blockchain's path from over- to underestimation
Progressing from proof of concept to production
In spite of high failure rates, blockchain is already in an advanced state of development by the standards of other technologies that have taken decades to develop. The decline of 'blockchain' being used as a buzzword to attract VCs has correlated with tangible progress in the development of production-grade blockchain systems in several verticals including banking, financial services, supply chain management and monitoring, and process development.
While many of these applications have been well documented, others have flown slightly under the radar. In the insurance industry, for example, the need to model contracts lends itself to a shared ledger of transactions – or a single version of the truth – that each party holds and engages with. Here, firms such as Allianz have prototyped blockchain systems that vastly reduce the paperwork and contract reconciliations necessary for the filing of claims between different jurisdictions by handling the contract, administration, and the settling of cross-border payments. More importantly, smart contract functionality provides for transparent and secure management of claims by customers and insurers, with all contracts and claims recorded on the blockchain and validated by the network. This eliminates the issue of duplicates, as multiple claims for the same accident is rejected by the blockchain.
Figure 2 : Blockchain spending sector, spending shares, 2017, 2021
The ability to efficiently create a tamper-proof log of sensitive activity securely, also makes blockchain well-suited for international currency payments. For example, the "Santander One Pay FX" service, uses the xCurrent from Ripple to allow customers to make same-day international transfers. By automating the whole process on the blockchain, Santander has reduced the required number of intermediaries in these international transactions, making the process more efficient and cheaper for retail clients. Additionally, cryptocurrencies backed by traditional currency, or stablecoins, are increasingly in demand for international payments due to their ability to protect against the volatility of cryptocurrency. Here, blockchain payment service provider Bitpay partnered with Binance in April 2020 to support stablecoin BUSD for the exchange and is now available to BitPay's 2 million individual and merchant customers.
Unblocking the key barriers to wider adoption
The above are just two examples of many which reflect blockchain's journey to post-hype maturity as the technology progresses beyond proof of concept. Indeed, Deloitte's annual blockchain survey indicated that the diversity of blockchain applications is increasing both within and between Fintech and other sectors, as executives take a more pragmatic approach toward its adoption.
However, there are still several barriers to overcome for broader adoption, particularly when seen in the context of the 90%+ failure rate of early blockchain ventures, and business leaders, investors, service providers, and end-users must take stock of these issues in order to get a well-rounded perspective on how blockchain's utility and capacity is changing:
1. A Lack of decision-making data
Relative to other emergent technologies for which vast volumes of historical business and operational data exist, very little data exists on the particulars of business outcomes for blockchain given its low mileage in industry. The paucity of data presents challenges to gauge ROI and raises the level of perceived investment, a state of affairs that is not helped by the fact that 43% of executives still believe the technology is over-hyped, according to Deloitte's survey.
At the same time, companies often have an immense amount of data spread across
legacy relational database management system (RDBMS), custom application stores, workbooks, and other data stores, making it very difficult for these stores of siloed, variable data warehouses to be leveraged by decision-makers in a meaningful way. This creates friction within an enterprise and illustrates why blockchains are so powerful in supply chain management, where trustworthy transactional data needs to be co-owned and co-operated by multiple entities.
2. Investor and stakeholder confidence remains a challenge
Even though blockchain has moved beyond the bold claims of 'disrupting everything' to achieve a baseline level of adoption, the early use and abuse of blockchain as a buzzword has dampened investor interest. Of course, this phenomenon has also been partially driven by the 'technology in search of a problem approach' during the 2016-18 period, when there was an over-saturation of ventures pushing blockchain for the sake of getting it in the tech stack without real market interest behind it.
A World Economic Forum survey measuring attitudes public and private sector leaders revealed that respondents predicted an average return on investment of 24% on their early blockchain ventures, but realised a return of only 10%. These poor returns combined with the fact that in the minds of many business leaders, blockchain remains inextricably linked to bitcoin, whose huge volatility and 80% swings make for dramatic headlines, have shaken investor confidence and led to a sharp contraction in funding for blockchain start-ups since 2019 (Figure 3).
Figure 3: Q4 funding to blockchain companies declines year-over-year
3. Regulation and compliance
From the UK High Court's judgment recognising bitcoin as property to the guidance published by the US Commodity Futures Trading Commission (CFTC) on what constitutes "actual delivery" for digital assets, regulatory alignment of crypto-assets, cryptocurrencies, digital tokens, and others, has become inescapable due to their representing entirely new representations of value made possible by blockchain technology. It follows, therefore, that such regulatory alignment is also necessary for blockchain in industry, both in order to match its applications to the transaction intricacies of specific industries, as well as for the application of general legislation for data protection/management such as the GDPR. Indeed, several key elements of the blockchain's data structure are not easily compatible with changes to regulation and compliance frameworks. For example, looking at the three principles of GDPR:
1. Lawfulness, fairness and transparency
2. Purpose limitation
3. Data minimisation
5. Storage limitations
6. Integrity and confidentiality
Though some of the above principles such as integrity and transparency align with blockchain architecture, others such as purpose and storage limitation do present problems. This is simply because the 'immutability of records' principle means that data contained on the blocks are virtually impossible to modify or delete, making it fundamentally at odds with GDPR requirements of retaining data only for a necessary limited period. Additionally, the fact that blockchain replaces a single actor with multiple parties presents a barrier to the GDPR which requires a single identifiable authority that can enforce data protection rights.
As mentioned above, data often sits in several different locations, and copying and transferring data is important to create a standard collection of data for analysing and operating applications. However, in reference to data formatting and syntax,
the datastores do not 'speak the same language'. This leads to additional complexity of navigating through data sets, building integrations, and running procedures for harmonisation.
“I want to ensure that the solution I deploy can work well with solutions other people deploy, even if we’ve made very different technology choices”
– Richard Gendal Brown, CTO, R3
If blockchain is applied to a distributed network, this further compounds the issue as there are now datastores at every member node tenant. For each of the related datastores, each of these nodes may have a different schema and different data elements and a transition layer is required for the disparate interpretation of data by other nodes. Here, a lingua franca is desired across all nodes but in practice it can be difficult to decide on. Here, a number of big-name web service providers such as IBM, Oracle, Azure Blockchain Services and SAP have been lobbying for more industry support for the development of cross-chain platforms.
5. Security Concerns
Blockchain technology is inherently secure because it eliminates any single point of failure by spreading data across multiple nodes. Additionally, cryptographic consensus mechanisms make it very difficult to hack a blockchain. Despite these fundamental safety features, blockchains are also subject to a range of security threats. For example, blockchains are susceptible to 51% attacks, where one or more malicious actors gain majority control of the hashrate of a blockchain to conduct double-spending, and prevent other miners from verifying blocks. Popularised by HBO's 'Silicon Valley', several real world 51% attacks have had a major impact on the cryptocurrency space such as in May of 2018, when the attackers were able to double-spend for several days, eventually stealing more than $18 million worth of the Bitcoin Gold cryptocurrency.
Other forms of attacks also exist, such as software flaws in decentralised applications, which themselves can be susceptible to bugs even if built on top of the most robust blockchains such as bitcoin or ethereum. For example, it is estimated that software bugs in wallets and decentralised apps and wallets led to losses in excess of $24 million in damages in 2018 and an increasing frequency of malware reports is becoming a growing concern for those in the Fintech and crypto space as well for businesses using tokenised assets.
Consortia and regulatory alignment will remain key
As seen in public sector blockchain adoption, all the talk of disruptive potential is now transitioning to real-world, tangible gains that are vindicating early-adopters. Yet many firms still struggle to justify development spending to satisfy decision-makers and stakeholders. The vast majority of businesses and enterprises will never get anywhere close to building a blockchain network due to the innovation risks, undefined standards, interoperability issues, and the uncertainty around competitor strategies.
But this is not necessarily a negative for the industry. A rapid increase in blockchain initiatives and consortia that pool industry-wide knowledge, expertise and resources to forge networks focused on blockchain-derived solutions for specific business pain points, are a manifestation of the attempt to lower the barriers to entry through cutting costs, reducing transaction fees, influencing regulatory standards, and sharing risk. It does mean that companies relinquish some of the control over the direction in which the platform develops, however, given the lack of vendor lock-in in and reduced innovation risk, the 'get what you pay for' SaaS model will be a central pillar for private sector blockchain development.
Regulatory alignment will also remain front and center of blockchain development. For example, so far no consensus on how exactly participating parties in a blockchain should be arranged for data protection purposes has been reached, nor have adequate technical solutions to the issues surrounding data minimisation been proposed. There is a real need for further interdisciplinary research carried out by private sector blockchain consortia as well as groups such as the EU Blockchain Observatory and Forum, to develop the legal and technical frameworks that will lower these barriers going forward. Ultimately, regulatory oversight must be balanced with the need to foster financial innovation.