Q&A: Blockchain and the next industrial revolution

05-30-2018

Best known for its association with virtual currency bitcoin, blockchain technology is being tapped by global banks, governments, tech and medical industries and other users of big data. We asked Portfolio Manager Steve Chiavarone for his thoughts on blockchain’s potential impact on our lives and for investors.

Q: First, what is blockchain? Blockchain is a means of verifying information and establishing trust in an increasingly digital economy. It’s a decentralized, autonomous, encoded digital record that allows transactions to occur and be continuously updated in a way that is secure, transparent and difficult to manipulate. What the internet is to information, blockchain is to value. You can think of it as supply chain management at an advanced level with the potential to securely and quickly track and verify any movement of money, goods, information or services.

Q: How does it work? The process begins with a business, service provider or individual initiating a transaction that is encrypted and simultaneously broadcast to a public or private network of computers around the world. Depending on the transaction, the network’s size can range from a few to hundreds to thousands of participants. Using algorithms, these computers track and verify updates to the transaction at every step. Each update or transaction in the thread is called a block and is added to blocks of all other data connected to that thread—hence the name (see related infographic, “The power of blockchain”). A blockchain can only be updated by consensus among participants in the system with each block time stamped and linked to a specific participant to ensure transparency.

Q: Similar to Wikipedia? It is similar in that there are multiple points of entry with different people across the network inputting data into the digital ledger. Information in the ledger can’t be added, changed or removed without being detected—and agreed upon—by other participants. 

Q: What’s the benefit? Consider that most transactions today—from financial settlements to government and medical recordkeeping to insurance and shipping contracts—are processed through a central clearinghouse or back-office operation. These are time, labor and cost-intensive processes—lots of people, lots of paperwork.

Because we’re putting chip content on so many things, it’s now possible to create a streamlined, digital infrastructure. That means that companies and individuals across the globe can do business without relying on a bureaucratic intermediary. It’s likely to be part of the next industrial revolution built on five complimentary technologies: automation, artificial intelligence, robotics, the internet of things and blockchain. They all have the ability to increase efficiency, create a structural higher-margin profile for companies and lower costs. It’s not surprising that governments, businesses and service providers are interested.

Q: Who is using blockchain today? Research firm Gartner estimates that blockchain’s value-add will grow to $176 billion by 2025 and skyrocket from there, so you can bet all the major firms—finance, tech and e-commerce—are heavily involved. Probably the most-used blockchain is Ethereum, which is a blockchain infrastructure that allows for the creation of smart contract systems. But there are some interesting examples of blockchain at a smaller scale. A former iconic camera manufacturer is reinventing itself by launching a coin that enables photographers to both store photos and license them directly off the blockchain. As a result, they can track the use of their images and payments for those images. One of China’s largest fine wine importers is using a blockchain to track bottles coded with a unique cryptographic tag. Wine buyers can verify the wine’s legitimacy by looking up the code to see every stop that wine has made. Blockchain ledgers are also being used by the diamond trade to allow regulators, banks and merchants to ensure legitimacy and conflict-free practices by tracing stones from the point they are mined to when they are sold to consumers.

Q: Who’s likely to benefit most? No one is investing more in this technology than global banks. Think about using your debit card and seeing the transaction as pending for the next three days. With blockchain, the transaction would be completed in minutes across an immutable and highly trusted process. No need for back-office reconciliation. The operational efficiencies become enormous. Banks that are able to get out ahead with this technology have the potential to cut costs significantly while also offering more secure and faster service to clients at less cost. That’s a big competitive advantage.

But you can go industry by industry and see benefits. Virtually any industry where supply chain management is important could benefit from the efficiencies brought by blockchain. On example is health care. Think about all the medical data that exists and how inefficiently it is being stored and used—whether by individual patients, for understanding treatment effectiveness across large populations or in terms of operating efficiencies. Big tech is another. Compared to server systems used today, blockchain will enable the storage of much larger quantities of data because companies are no longer limited to a single source of computing power. The ability to access and to authenticate exponentially more data will result in more nuanced insights and analysis. That, in turn, can lead to more innovations and breakthroughs.

Q: What is challenging wider implementation of blockchain systems? A key issue is lack of consolidation around a standard operating protocol, not unlike the early days of the internet. At that time there wasn’t a way for computers within discrete intranet networks to interface with computers outside that network. It took many years, but eventually a standard protocol was widely adopted so that today all of the locally controlled intranets around the globe can efficiently connect to the web and share vast amounts of information. And that has essentially changed the world.

It may take some time for blockchain standards to be implemented. Companies and innovators continue to develop and test blockchain systems. But the incentives of efficiency, security and profitability will likely accelerate greater adoption of the technology along with those protocols.

Q: How are investors thinking about blockchain? There is opportunity both in companies that are creating the technologies that make blockchain possible as well as those with the ability to put it to use. Hardware makers—companies that produce graphic processing units, semiconductors and memory chips—have potential to strongly benefit given the immense computing power that is needed. Infrastructure, software and protocol developers have a major role to play. Also, companies that are able to process and make sense of data—all the big tech and info-tech companies as well as biotech firms stand to gain from blockchain and related systems.

This is a new and potentially transformative technology, so there will be plenty of trial and error ahead. As investment managers, our job is do the research to identify strong opportunity and avoid pitfalls.

Thanks, Steve.