Distributed Ledger - Strengths That Warrants Its Adoption

Blockchain is the most talked about technology today that is likely to have a pervasive impact on all industry segments, more specifically in the Banking and Financial Services. Blockchain packs the principles of cryptography, game theory and peer-to-peer networking. Blockchain, once the formal name for the tracking database underlying the cyptocurrency bitcoin, is now used broadly to refer to any distributed ledger that uses software algorithms to record transactions with reliability and anonymity. An increasingly interesting aspect of blockchain use is the concept of smart contracts – whereby business rules implied by a contract are embedded in the blockchain and executed with the transaction.


Built on the peer-to-peer technology, blockchain uses advanced encryption to guarantee the provenance of every transaction. The secure and resilient architecture that protects the distributed ledger is on of its key advantage. The other benefits of block chain include reduction in cost, complexity and time in addition to offering trusted record keeping and discoverability. Blockchain has the potential to make trading processes more efficient, improve regulatory control and could also displace traditional trusted third-party functions. Blockchain holds the potential for all participants in a business network to share a system of record. This distributed, shared ledger will provide consensus, provenance, immutability and finality around the transfer of assets within business networks.


The Banking and Financial Services industries world over are seriously looking at this technology. The Central Banks in many countries including India have formed committees to evluate the adoption of the blockchain technology, which is expected to address some of the problems that the industry is wanting to overcome over many years. For the financial services sector blockchain offers the opportunity to overhaul existing banking infrastructure, speed settlements and streamline stock exchanges. While many institutions understand its potential, they are still trying to work out whether blockchain technology offers a cost-cutting opportunity or represents a margin-eroding threat that could put them out of business.

Like the Cloud Computing, there three categories of blockchain, public, private, and hybrid. A public block chain is a fully decentralized “trustless” system open to everyone and where the ledger is updated by anonymous users. A private blockchain finds its use within a bank or an institution, where the organization controls the entire system. Hybrid is a combination of both public and private implementations, which is open to a controlled group of trusted and vetted users that update, preserve, and maintain the network collectively. Blockchain exploration has propelled banks in multiple directions, from examining fully decentralized systems that embed bitcoin or other virtual tokens to function, to ones where only authorized and vetted users are granted ac-cess to a network. 

The technology is being commercialised by several industry groups and are coming out with the use cases that this technology will be suitable for across different industry vertical. With the surge in funding for the FinTech innovations, the block chain technology may find its retail and institutional adoption in about 3 to 5 years, while some expect that this will take even longer. Some have invested in in-house development, while others have partenered with others in their pursuit to adopt the blockchain as part of their main stream business technology. 

Listed here are some of the key strengths that drives the adoption of the technology worldover.

Trusted

With the frequency at which data breaches are happening, users are seeking to have control over sensitive data. Blockchain by its nature puts users in total control. Applied to payments, blockchain allows users to retain control of their information and enable access to information about only one act of transaction. Participants are able to trust the authenticity of the data on the ledger without recourse to a central body. Transactions are digitally signed; the maintenance and validation of the distributed ledger is performed by a network of communicating nodes running dedicated software which replicate the ledger amongst the participants in a peer-to-peer network, guaranteeing the ledger’s integrity. They will also want the ability to roll back transactions in instances of fraud or error – which can be done on blockchain by adding a compensating record, as long as there are permission mechanisms to allow this – and a framework for dispute resolution.

Traceability

The cryptographic connection between each block and the next forms one link of the chain. This link ensures the  maintenance of trace for the information flow across the chain and thus enabling the articipants or regulators to trace information flows back through the entire chain. The distributed ledger is immutable as entries can be added to, but not deleted from. This information potentially includes, but is not limited to, ownership, transaction history, and data lineage of information stored on the shared ledger.  If provenance is tracked on a blockchain belonging collectively to participants, no individual entity or small group of entities can corrupt the chain of custody, and end users can have more confidence in the answers they receive.

Resiliency

Operates seamlessly and removes dependency on a central infrastructure for service availability. Distributed processing allows participants to seamlessly operate in case of failure of any participants. Data on the ledger is pervasive and persistent, creating a reliable distributed storage so that transaction data can be recovered from the distributed ledger in case of local system failure, allowing the system to have very strong built-in data resiliency. Distributed ledger-based systems would be more resilient to systematic operational risk because the system as a whole is not dependent on a centralised third party. With many contributors, and thus back-ups, the ledger has multiple copies which should make it more resilient than a centralised database. 

Reconciliation

Use cases that centre on increasing efficiency by removing the need for reconciliation between parties seem to be particularly attractive. Blockchain provides the benefits of ledgers without suffering from the problem of concentration. Instead, each entity runs a “node” holding a copy of the ledger and maintains full control over its own assets. Transactions propagate between nodes in a peer-to-peer fashion, with the blockchain ensuring that consensus is maintained. Reconciling or matching and verifying data points through manual or even electronic means would be eliminated, or at least reduced, because everyone in the network accessing the distributed ledger would be working off the exact same data on the ledger. In the case of syndicated loans, This is more so, since information is mutualised and all participants are working from the same data set in real time or near-real time. .

Distributed

When a blockchain transaction takes place, a number of networked computers, process the algorithm and confirm one another’s calculation. The record of such transactions thus continually expands and is shared in real time by thousands of people. Billions of people around the world lack access to banks and currency exchange. Blockchain-based distributed ledgers could change this. Just as the smartphone gave people without telephone lines access to communication, information, and electronic commerce, these technologies can provide a person the legitimacy needed to open a bank account or borrow money — without having to prove ownership of real estate or meeting other qualifications that are challenging in many countries.

Efficiency Gains

Removal of slow, manual and exception steps in existing end-to-end processes will lead to significant efficiency gains. Blockchain also removes the need for a clearing house or financial establishment to act as intermediary facilitating quick, secure, and inexpensive value exchanges. Blockchain ensures the most effective alignment between usage and cost due to its transparency, accuract and the significantly lower cost of cryptocurrency transaction. Distributed ledger technology has the potential to reduce duplicative recordkeeping, eliminate reconciliation, minimise error rates and facilitate faster settlement. In turn, faster settlement means less risk in the financial system and lower capital requirements

Surviving Disruptive Innovations

I have recently made a presentation on Disruptive Technologies at the Chennai Chapter of ISACA. While chose the topic in the context of presenting a picture of the pace at which the disruption is happening in IT world and what are the upcoming Disruptions to watch out for. But As I was preparing the agenda and content for the presentation, I was curious to find out how successful enterprises are managing rather surviving disruptions and in the process have stumbled upon some of the research work done by Clayton Christensen.


It was interesting to observe few things from his theory, which are the following:


Good Management principles would not be of great help in managing or surviving the disruptive innovations. Christensen sites the examples of how Toyota came up disrupting General Motors. He sees a pattern in the happening of disruptions in the form of an S curve, where the top of the curve is a cliff. Leaders / Leadership teams follow the bese management principles to climb up the S Curve and when they reach top they just fall off the cliff.


Extendable core is the key enabler of of innovations becoming disruptive. The potential disruptive innovations would appear as if it is insignificant in terms of the competitive capabilities of the incumbent’s existing products and thus tempting the incumbent to ignore it. But having an extendable core within it, the new entrant quietly enhances its capabilities and slowly get into the mainstream market of the incumbent and then disrupting a whole market resulting in driving the big and well managed incumbents out of the market.


Emerges from where it is least expected. For example, we now find it very comfortable to use a smartphone to various jobs which otherwise were performed by some special purpose devices. Examples include GPS devices, Digital Cameras and even PCs. While GPS device manufacturers still believe that GPS feature of Smartphone is not a threat for them as the special purpose GPS devices have certain unique advantages, which Smartphones don’t. But be reminded that the smartphones have the extendable core and can easily address this capability gap and soon GPS devices will be a thing of the past and we are already seeing the signs of it.


While there are many other interesting observations to note, I would leave it for you to find those out. I was then curious to look into the cases of disruptions that happened in the past. the following three cases of disruptions were of interest to me:


Kodak: Kodak ruled the photography market for a whole century. Their management as all the best qualities and were praised in all respects. Kodak has many innovations to its credit and have many firsts as well. With such a performance it has recently gone into bankruptcy and has sold its patent portfolio, which included close to 1000 patents to salvage some value. It is natural for us to think that the emergence of Digital Cameras would have disrupted Kodak in a big way. But as many would know, Kodak knew that digital era is emerging and they were the first to introduce a Digital Camera in the 1970s. But then what went wrong and how did they miss to sustain that innovation and stay alive in the market? Kodak has been believing till early 200 that the Photographic films wouldn’t die so soon. The other interesting observation out of Kodak’s failure is that with a heavyweight team of experts, sustaining innovation is really expensive and the outside view is most likely ignored.


That’s where the management tend to give up on some of the innovations as the time and investment in it may not worth it as they are making decent business with their current line of products. The situation is different for new entrants as the startups usually break the rules of convention and are in a position to pursue such innovations relatively a lot cheaper and also in an progressive manner. Startups usually start to focus a market which is ignored or to which the incumbents don’t pay much attention and there by not drawing the attention of the incumbents till a point when it will be difficult for the incumbent to respond to.


NOKIA: Nokia came big in the cellular phone, but failed to get its innovation strategy right with the smartphones. Even in NOKIA’s case, its research team came up with a prototype of smartphone with internet access and touch interface, way back in 2003, but the management, again going by good management principles, citing the risk involved in the product being successful and the very high cost of its development has turned down the proposal to pursue this plan further. Exactly three years later Apple launched its iPhone.


NetFlix: Netflix case is a little different. Netflix has been very successful in its DVD Rental business and in fact has seen the emergence of disruptive innovations in the form of streaming videos. It even responded to it by pursuing its research activities in that direction and has developed a service of streaming videos. What went wrong according to analysts is that it got is business model and pricing wrong as it combined both the traditional service and the digital streaming service as a bundle and increased the pricing. Ideally it would have been more appropriate to have offered the digital streaming under a different brand or as a separate service, as the surveys indicated that the DVD rentals still account for 70% of the total video sales in the US.


Now, given that just good management principles don’t help in sustaining or surviving the disruptive innovations, what should the organizations do to stay alive in todays world where IT has enabled the disruptive innovations to emerge with much faster pace leaving very little time for the incumbents to respond to. We also keep hearing that the “break the rules” is the way to go to foster innovation. While disruption is always seen as a risk to be managed, how well enterprises come up with the right risk mitigation and contingency plans to handle the risk of disruption is still a mystery.

You may check out my presentation on the subject at Slideshare and feel free to share your views and thoughts on this topic. You may google to find out some of the great articles and papers on the theory of disruptive innovation by Clayton Christensen. You will also find some good video lectures of his on YouTube.