Today there are very few technologies that are getting as much attention as the Blockchain, the technology that powers Bitcoin. Gone are the days when Bitcoin or Blockchain was the sole preserve of few clever coders, spread across the world. Today there is a growing interest in the technology among people and more are signing up each month to experiment and use Bitcoin and other cryptocurrencies (also known as Altcoin).
Businesses too have started looking at Blockchain closely, their interests, however, are more in the underlying technology than in cryptocurrency. As this technology seems set to disrupt several existing businesses and business models, so for enterprises it is not just a matter of reviewing technology for its best use, but it is a matter of ensuring not losing business and staying relevant.
The technological innovations and the rapid pace with which new changes are unleashing in this space have prompted many to compare the Blockchain technology evolution to the web revolution of the early 90s. Irrespective of what the technology’s place will be in history, there is little doubt about its versatility and how broadly it can be applied.
Despite the growing attention, these are still early days for the technology. For startups and SMBs, this presents a unique opportunity to look around and think creatively about ways in which the technology can be used to solve some of the current problems.
Startups or SMBs can either build standalone products on top of the Blockchain to serve a specific unmet market need or can build products that solve a problem for a large company or industry sector. There are use cases in almost every industry and new ones keep getting added nearly every month. However, being a nascent technology most use cases are at Proof-of-concept (PoC) stage and not into production.
At the height of the global financial crisis, on Oct 31, 2008, there appeared a White Paper in a cryptographic mailing list by one Satoshi Nakamoto. Till this day no one knows who the person or group behind this name is. In the paper, a digital currency called Bitcoin was introduced as a peer-to-peer electronic cash transfer system.
Bitcoin was envisioned as a system of borderless digital currency that was not subject to any central authority and totally independent and non-reliant on fiat currencies of the countries. The idea was to set the world free from the current global financial system and its vagaries that were most evident during the financial meltdown.
In Jan 2009, Satoshi launched the software for Bitcoin and created the first Bitcoin by creating the first block, the genesis block, on the Blockchain, thus starting an entirely new era of cryptocurrency.
What Satoshi introduced was nothing less than a remarkable breakthrough innovation, yet like most innovations of the past, the underlying concepts used in Bitcoin weren’t entirely novel. The technology behind each feature of Bitcoin had been in existence for decades. Satoshi’s genius lies in combining those mostly forgotten technologies of the past and turning them into a strong secure and innovative digital currency.
At the most basic level, a Bitcoin is an electronic token which can be transacted over a technology platform called Blockchain.
Of the technologies employed in Bitcoin, first is encryption. Information stored on a Bitcoin is encrypted using a cryptographic hash algorithm called SHA-256 which has been in existence for a long time. SHA-256 converts any data input into a small fixed size Hexadecimal output. The only way to access information on this output is by unlocking it through a combination of encrypted keys. This encryption achieved by using the hashing algorithm forms the security layer of Bitcoin and can’t be broken into using any available technology today.
The second technology is the peer-to-peer data transfer technology, which can otherwise also be referred to as the Distributed Ledger Technology (DLT). The DLT ensures that the complete network has the same most updated copy of ledger of all transactions executed till date, as their ledger. This ensures that the ledger is not held in one central location and the same copy is on every user’s device and in case a device gets disconnected the network still has the same single source of truth.
This system is similar to BitTorrent file sharing system that was developed in the early 2000s. However, the way Bitcoin is different from BitTorrent is that in Bitcoin each block (a block consists of several transactions) contains a cryptographic reference of an earlier block (usually a Merkel root reference address from an earlier Merkel tree database structure) and this way the entire block is linked and so the name — Blockchain. Thus, the Blockchain is a specific type of Distributed Ledger System.
The third important technology piece is the consensus algorithm. A consensus algorithm is a mechanism used to reach an agreement collectively as a network, as to what the next block of the Blockchain should be. This agreed block is then appended to the Blockchain and the entire system is updated to the new version of the ledger, and this way the Blockchain continues to grow.
The way consensus is reached on the network is interesting to note. There is no voting involved. A consensus is reached automatically when a person requesting their block to be the next block on the Blockchain provide electronic evidence that they have put in the desired amount of work in identifying the new block. The evidence demonstration is done through something called as Proof-of-work (PoW).
The PoW consensus algorithm requires that any node (or group of nodes) pushing a block to be included as the next block (on the Blockchain) must have put in a certain level of compute power. The compute power invested is used to signal if transactions on the block are legit. If compute power criteria are met the block is automatically approved and added to the Blockchain. The specific type of PoW used by Bitcoin is called Hashcash which is otherwise used to prevent Distributed denial-of-services (DDoS) attack in the cybersecurity landscape.
The fourth piece of puzzle employed by Blockchain is the old Economic principle of Game Theory. Everybody on the network is inherently incented to put in the compute power to approve a Block. The way it works is that for each new Block added (finding a new Block is called Mining) the person behind (otherwise known as miners) that addition is rewarded 12.5 Bitcoin. And, so there is a constant race among miners to quickly verify transactions and create a new Block, and beat other miners to the 12.5 Bitcoin reward.
However, as soon as a miner declares they have a new block and pushes it to the network for verification, all miners must leave their Block search and instead quickly move to verify the newly declared block. This is because the sooner they verify a new block and add it to the Blockchain the sooner they will get the latest version of the ledger, which they will have to use to mine the new block.
As might also be evident that each miner has a vested interest in correctly verifying transactions as that helps secure the network of which they are a part. This way the network is self-secured by its members.
Cryptocurrency mining process
The computing process (also called as hashing power) is a very energy intensive activity. Back in the days when Bitcoin mining first started, using a PC was enough to mine. However, since then the Blocks have grown and so has the complexity required to mine a new Block. Mining using CPU of a PC was no longer possible, and so miners shifted to using their Graphic Processing Unit (GPU) before that also become unviable.
Today, miners use an Application-specific integrated circuit (ASIC), which is purpose built for mining a specific cryptocurrency only. An ASIC based mining rig has a much higher hashing rate and uses less electricity per hash. This combination makes it possible for miners to make money from an ASIC rig which can easily cost about $3000 and usually needs to be replaced within 6 months.
Despite the newer ASIC mining rigs being more energy efficient they still generate lots of heat and therefore must be kept in a cool environment. Further, the ASIC machines generate a high level of constant noise and therefore must be placed in special confined areas. All these special requirements make mining cryptocurrency an expensive endeavor and are slowly taking mining out of reach of an individual miner.
Business opportunity in cryptocurrency mining
An individual miner’s compute power is limited and so if their Block doesn’t get approved and added, which often happens, their invested Electric energy is wasted. To work around this problem, miners often work in groups and pool together their compute power. This raises the potential of getting the reward which then gets distributed among the pooling members.
Taking this a step further, there are now large specialized industrial scale Cryptocurrency mining farms spread across several acres. One such farm is the Genesis farm in Iceland. A farm like Genesis can easily generate upward of a million dollars each month. So, if a Startup or SMB can secure sufficient initial capital investment, starting its own mining farm might be a good business idea.
It is interesting to note that Genesis is based in Iceland where cost of Electricity is relatively low and Iceland being a cold country the cost of keeping the mine cool is lower. Likewise, China has good supply of cheap coal-power based Electricity and therefore nearly 60% of industrial scale Bitcoin mining happens in China. So, if an SMB or startup has the advantage of access to cheap Electricity and cold location, it might be a great idea to start a mining farm.
There are several limitations with the current Bitcoin system.
First, a new block is mined only once every 10 minutes. At any given time, there are well over 1000 unconfirmed transactions waiting to be included in a Block. Given that today only a very small percentage of people use Bitcoins, with more people getting on the network in future the number of unconfirmed transactions will only rise.
As the number of unconfirmed transactions on average goes up it will very quickly become a big scaling issue, which it already is today. Further, the current 10 minutes transaction approval latency we have today is an issue, as one can’t wait that long for getting payment confirmation especially when they are buying something as simple as a cup of coffee.
Next, the Proof-of-work (PoW) algorithm of Bitcoin was designed to keep increasing the algorithmic complexity over time, this was done to secure the system. However, increased complexity means increased compute power which in turn means increased energy consumption. Now, given world’s energy needs the amount of energy invested into mining doesn’t seem quite right.
Industry response to the limitations
The limitations of Bitcoin and also some creative thinking about technology’s possible uses have led to at least three different developments. First, is the development of different cryptocurrencies that are each created with the original intent of trying to address some specific problem not served by Bitcoin.
Second, to overcome the issues of scaling up and latency in confirming transactions, alternative consensus algorithms other than Proof-of-work (PoW) are being experimented with. The most interesting protocols being tried are Proof-of-Stake (PoS) and Proof-of-time-elapsed (PoET).
Third, is the moving away from Blockchain itself as the underlying DLT. Several systems are experimenting with different types of DLTs that are not Blockchain based and so the size of block or the chain itself is not large. This helps in reducing latency in confirming transactions.
Fourth, Businesses are exploring Blockchain and various other DLTs for serving their specific business needs. Businesses have certain requirements around privacy, security, collaboration, and performance. So, they are currently experimenting with the concept of private Blockchain as opposed to public Blockchain.
Building on the original Bitcoin concept of open source Blockchain, the business community has formed several alliances among themselves. These alliances are working on developing solutions for specific business needs, using open source code contribution by its various members. Three key alliances are worth noting.
First, is Enterprise Ethereum Alliance (EEA). EEA uses the Ethereum platform (that uses ether as its currency or token) the most popular platform after the Bitcoin. One of the most interesting features of Ethereum is the Smart contract, which is a set of pre-defined rules of engagement between different parties involved in a transaction. As soon as a certain smart contract listed condition is met, a transaction is automatically approved without requiring the same sort of consensus as in Bitcoin.
Second, is Hyperledger, which is a Linux Foundation led alliance. Hyperledger is trying to build a permissioned DLT as against the permissionless system of Bitcoin. So, members would need permission to join the network which is quite understandable in a business context. Since getting on a network requires permission therefore certain level of trust is already built into the system. Therefore, transaction approvals are done differently and don’t require approval like Bitcoin.
Third, is the ‘Trusted IoT Alliance’. The objective of this alliance is to set up a secure Blockchain network that will allow interconnected devices such as those on the Internet of Things (IoT) to communicate safely over a DLT network.
Distributed Applications (Dapps)
Dapp is a special application software that is created to serve specific needs. A Dapp can be easily linked to a Blockchain, thus gaining the strength of a secure Blockchain. Utilizing the strength of Blockchain there have been several Dapps built on top of the Distributed chain. Anyone can create and publish a Dapp. The development of Dapps has opened up a new set of possibilities and we see some of it being played out already. One such example is the Initial Coin Offering (ICO).
Initial Coin Offering (ICO)
An ICO is somewhat similar to an Initial Public Offering (IPO) in the sense that they are both intended to raise funds by giving a portion of the company in return for funds contributed. However, there are several nuances and one key differentiating aspect is that an ICO is a crowdsourced fund-raising activity where the funding medium is a cryptocurrency.
ICOs have been growing in popularity, and for the first time, early this year startup funding from ICOs overtook funding from the traditional VC route. There are certainly challenges with ICOs in their current state as there have been instances of scams and Ponzi schemes. This has led to regulators and governments taking a hard look at ICO markets. The Chinese government recently went a step further and banned ICOs completely. Yet, it seems ICOs are going to grow and over time people will get self-organized and assess ICOs more thoroughly before investing.
The development of smart contract has opened up lots of possibilities and also interesting business avenues. A smart contract enables a safe and secure transaction between anonymous entities without having to establish trust between them.
For instance, in traditional banking, banks intermediate between two parties wanting to transact and provide the needed trust for the secure transaction to happen between those parties. With smart contracts, such an intermediation is not required as people can securely transact directly without having to know or trust the other person.
This is disrupting the business model for organizations that act as intermediaries, and in several cases, it is making the role of an intermediary redundant.
Dapps are being developed to directly disintermediate in several industries. One example is the ride sharing industry. Uber or Lyft aggregate and bring together drivers and passengers through their central platform. Experiments are ongoing to build a secure platform that will allow a direct driver-passenger communication without the need of going through a central system. Similar disintermediation concept is being tested in the room renting industry against Airbnb.
Today, the number of industries that are developing solutions for specific use cases of Blockchain technology, is really growing fast. For instance, Healthcare industry is looking at safe and secure health record data communication between different agencies. The Supply Chain industry is looking at seamless transit information communication between different agencies thereby ensuring smooth flow of goods. The Food industry is developing solutions that will ascertain that the standard food storage and transportation conditions were met and that the food quality and its claims (e.g., Organic) are accurate.
The development of DLT in the last ten years has really been a significant innovation — one that is set to disrupt several industries and business models and spur innovation in unprecedented ways. The future developments certainly seem to be moving towards smaller private blockchains, permissioned networks, transactions not involving any token or cryptocurrency, and machine-to-machine transactions through smart contracts
Startups and SMBs should closely examine this technology and see how it can be applied to their industries. There are primarily two ways in which Startups and SMBs can come up with unique business opportunities. First, is by looking at potential areas which can benefit from disintermediation. Second, is by finding areas that will benefit from not having to trust the participants when transacting with them.
The technology is still in its early days and now is the best time for Startups and SMBs to get involved and benefit from the fascinating innovations that are unfolding.