Blockchain’s Occam problem PART I
Blockchain has yet to become the game-changer
some expected. A key to finding the value is to apply the technology only when
it is the simplest solution available.
Blockchain over recent years has been extolled as a revolution in business
technology. In the nine years since its launch, companies, regulators, and
financial technologists have spent countless hours exploring its potential. The
resulting innovations have started to reshape business processes, particularly
in accounting and transactions.
Amid intense
experimentation, industries from financial services to healthcare and the arts
have identified more than 100 blockchain use cases. These range from new land
registries, to KYC applications and smart contracts that enable actions from
product processing to share trading. The most impressive results have seen
blockchains used to store information, cut out intermediaries, and enable
greater coordination between companies, for example in relation to data
standards.
One sign of
blockchain’s perceived potential is the large investments being made.
Venture-capital funding for blockchain startups reached $1 billion in 2017. IBM
has invested more than $200 million in a blockchain-powered data-sharing solution
for the Internet of Things, and Google has reportedly been working with
blockchains since 2016. The financial industry spends around $1.7 billion
annually on experimentation.
There is a clear sense
that blockchain is a potential game-changer. However, there are also emerging doubts. A particular concern, given the amount of money and
time spent, is that little of substance has been achieved. Of the many use
cases, a large number are still at the idea stage, while others are in
development but with no output. The bottom line is that despite billions of
dollars of investment, and nearly as many headlines, evidence for a practical
scalable use for blockchain is thin on the ground.
Infant technology
From an economic theory
perspective, the stuttering blockchain development path is not entirely
surprising. It is an infant technology that is relatively unstable, expensive,
and complex. It is also unregulated and selectively distrusted. Classic lifecycle
theory suggests the evolution of any industry or product can be divided into
four stages: pioneering, growth, maturity, and decline (exhibit). Stage 1 is
when the industry is getting started, or a particular product is brought to
market. This is ahead of proven demand and often before the technology has been
fully tested. Sales tend to be low and return on investment is negative. Stage
2 is when demand begins to accelerate, the market expands and the industry or
product “takes off.”
Exhibit in original article
Across its many
applications, blockchain arguably remains stuck at stage 1 in the lifecycle
(with a few exceptions). The vast majority of proofs of concept (POCs) are in
pioneering mode (or being wound up) and many projects have failed to get to
Series C funding rounds.
One reason for the lack
of progress is the emergence of competing technologies. In payments, for
example, it makes sense that a shared ledger could replace the current highly
intermediated system. However, blockchains are not the only game in town.
Numerous fintechs are disrupting the value chain. Of nearly $12 billion
invested in US fintechs last year, 60 percent was focused on payments and
lending. SWIFT’s global payments innovation initiative (GPI), meanwhile, is addressing initial pain
points through higher transaction speeds and increased transparency, building
on bank collaboration.
Blockchain players in
the payments segment, such as Ripple, are increasingly partnering with nonbank
payments providers, the businesses of which may be a better fit for blockchain
technology. These companies may also be willing to move forward more rapidly
with integration.
In addition, the
payments industry faces a classic innovator’s dilemma: incumbents understand
that investing in disruption, and the likely resulting rise in customer expectations
for faster, easier, and cheaper services, may lead to cannibalization of their
own revenues.
Given the range of
alternative payments solutions and the disincentives to investment by
incumbents, the question is not whether blockchain technology can provide an
alternative, but whether it needs to? Occam’s razor is the problem-solving
principle that the simplest solution tends to be the best. On that basis
blockchain’s payments use cases may be the wrong answer.
Industry caution
Some sense of this
dilemma is starting to feed through to industry. Early blockchain development
was led by financial services, which from 2012 to 2015 assigned big resources
where it was felt processes could be streamlined. Banks and others saw
activities such as trade finance, derivatives netting and processing, and
compliance (alongside payments) as prime candidates. Numerous companies set up
innovation labs, hired blockchain gurus, and invested in start-ups and joint
ventures. A leading industry consortium attracted more than 200 financial
institutions to its ecosystem, conceived to deliver the next generation of
blockchain technology in finance.
As financial services
led, others followed. Insurers saw the chance for contract and guarantee
efficiencies and the potential to share intelligence on underwriting and fraud.
The public sector looked at how it could update its sprawling networks,
creating more transparent and accessible public records. Automakers envisaged
smart contracts sitting on top of the blockchain to automate leasing and hire
agreements. Others spotted a chance to modernize accounting, contracting, and
fractional ownership and to create efficiencies in data management and supply
chains.
By the end of 2016,
blockchain’s future looked bright. Investment was soaring and some of the
structural challenges to the industry appeared to be fading. Technical glitches
were being resolved and new, more private versions of the ledger were launched
to cater to business demands. Regulators appeared to be more sanguine than
previously, focusing on communication, adaptation, and debate rather than
impediment.
From an industry
lifecycle perspective, however, a more complex dynamic was emerging. Just as
the financial services industry’s blockchain investments were reaching the end
of Stage 1—theoretically the moment when they should be gearing up for
growth—they appeared to falter.
Emerging doubts
McKinsey’s work with
financial services leaders over the past two years suggests those at the blockchain
“coalface” have begun to have doubts. In fact, as other industries have geared
up, the mood music at some levels in financial services has been increasingly
of caution (even as senior executives have made confident pronouncements to the
contrary). The fact was that billions of dollars had been sunk but hardly any
use cases made technological, commercial, and strategic sense or could be
delivered at scale.
By late 2017, many
people working at financial companies felt blockchain technology was either too
immature, not ready for enterprise level application, or was unnecessary. Many
POCs added little benefit, for example beyond cloud solutions, and in some
cases led to more questions than answers. There were also doubts about
commercial viability, with little sign of material cost savings or incremental
revenues.
Another concern was the
requirement for a dedicated network. The logic of blockchain is that
information is shared, which requires cooperation between companies and heavy
lifting to standardize data and systems. The coopetition paradox applied; few
companies had the appetite to lead development of a utility that would benefit
the entire industry. In addition, many banks have been distracted by broader IT
transformations, leaving little headspace to champion a blockchain revolution.
The key question now is
whether those doubts are still justified. Or whether it is just that progress
in blockchain development has been slower than expected.
Over recent months some
financial institutions have begun to recalibrate their blockchain strategies.
They have put POCs under more intense scrutiny and adopted a more targeted
approach to development funding. Many have narrowed their focus from tens of
use cases to one or two and have doubled down on oversight of governance and
compliance, data standards, and network adoption. Some consortia have shrunk
their proof of concept rosters from tens in 2016 to just a handful today.
The emergence of
cryptocurrencies, and in particular Bitcoin, as potential mainstream financial
instruments prompted financial services to move first on blockchain
experimentation, placing them 18 to 24 months ahead of other industries on the
industry lifecycle. Given that gap, it is not surprising that the earlier
concerns in banking are now emerging elsewhere, with initial enthusiasm being
eroded by a growing sense of underachievement.
The reality is that
rather than following the classic upward curve of the industry lifecycle,
blockchain appears to be stalled in the bottom left-hand corner of the X-Y
graph. For many, stage 2 isn’t happening. As we enter 2019, blockchain’s
practical value is mainly located in three specific areas:
·
Niche
applications: There are
specific use cases for which blockchain is particularly well-suited. They
include elements of data integration for tracking asset ownership and asset
status. Examples are found in insurance, supply chains, and capital markets, in
which distributed ledgers can tackle pain points including inefficiency,
process opacity, and fraud.
·
Modernization
value: Blockchain
appeals to industries that are strategically oriented toward modernization.
These see blockchain as a tool to support their ambitions to pursue
digitization, process simplification, and collaboration. In particular, global
shipping contracts, trade finance, and payments applications have received
renewed attention under the blockchain banner. However, in many cases
blockchain technology is a small part of the solution and may not involve a true
distributed ledger. In certain instances, renewed energy, investment, and
industry collaboration is resolving challenges agnostic of the technology
involved.
·
Reputational
value: A growing number
of companies are pursuing blockchain pilots for reputational value;
demonstrating to shareholders and competitors their ability to innovate, but
with little or no intention of creating a commercial-scale application.
Arguably blockchains focused on customer loyalty, IoT networking and voting
fall into this category. In this context, claims of being “blockchain enabled”
sound hollow.
CONTINUES
IN PART II
By Matt Higginson, Marie-Claude
Nadeau, and Kausik Rajgopal
https://www.mckinsey.com/industries/financial-services/our-insights/blockchains-occam-problem.?cid=other-eml-alt-mip-mck&hlkid=9f09737f325e4674836f3a01887bcd87&hctky=1627601&hdpid=95e9bdfa-0709-4b4d-8252-f401bcaac86d
No comments:
Post a Comment