Blockchain Adoption – Finance Won’t Be The First Place To Embrace The Technology

Blockchain, Innovation | July 11, 2018 By:

Since the invention of Bitcoin in 2009, the blockchain industry has been on a mission to disrupt Banks and financial services.

Bitcoin was birthed into the failure of traditional banks to responsibly manage lending practices, which lead to a real estate market crash that destroyed trillions of dollars in global wealth.

Since then, the blockchain industry has produced hundreds of decentralized applications for finance to tackle lending, remittances, investing, payments and a variety of other services that provide more efficiency, security and autonomy in how we manage our money.

Yet despite this progress, there are still many barriers preventing blockchain technology from truly disrupting the mainstream financial system.

As blockchains struggle to achieve scalability and regulators enforce laws to control cryptocurrencies, we may start to see blockchain adoption stagnate in the finance space, while it picks up speed in other areas that are more adept to change.

Let’s look at the likelihood of adoption through a lense of 4 components:

  1. Scale of Impact: how much does the industry impact everyday people?
  2. Regulatory barriers: are the laws compatible with the value proposition of blockchain technology?
  3. Technology requirements: how advanced does the blockchain need to be?
  4. Customer switching costs: how much cost (in time and money) does the person or entity incur when switching to a blockchain solution?

Scale of Impact

When evaluating an industries capacity for blockchain disruption, we need to first ask ourselves how much of an impact the industry has on people’s everyday lives.

Banks and financial services are the cornerstone of our global economic system.

According to the Organization for Economic Co-operation and Development (OECD), financial services typically make up 20-30% of total service market revenue and about 20% of the total gross domestic product in developed economies.

Every human being at one point or another will utilize a financial service to store their funds, take out a loan, make or receive a payment, etc.

By comparison, the market value for the supply chain industry is about 12% of global GDP.  This industry is equally as ubiquitous as Finance, but affects people’s lives in much more indirect way. For example, ecommerce and retail are 2 consumer facing industries that benefit significantly from more efficient supply chain processes. Global trading of commodities (grain, precious metals, electricity, oil, etc) influences the overall health and well-being of importing nations, as well as the wealth of exporting nations.

Regulatory Barriers

The second component is the regulatory barriers to adoption.

This is where supply chain arguably has a slight advantage over finance. Although the supply chain industry has its own share of regulations, blockchain solutions can be implemented in a way that not only complies with current regulations, but also enhances them.

For example, the, Transparency on Trafficking and Slavery Act requires companies to file annual reports with the SEC disclosing efforts to address specific human rights risks in the supply chain. As a manufacturing company, the best way to comply with this act would be to develop a decentralized database that tracks the digital ID and payment schedules of employees working in the factory. This way the company could prove to regulators that their workers are of an appropriate age, and that they are fairly compensated. All information would be immutable and secured through the blockchain.

In other examples, the FDA is tightening its legislation around food sanitation, requiring companies to ensure food safety with the Sanitary Transport Rule.

The U.S. government is also cracking down on the sourcing of conflict minerals such as tungsten, tin, titanium and gold in order to stop militia groups that are funded from the sales of these minerals.

For both of these cases, details about the items being shipped (their location, date of production, the names of people and checkpoints in which they pass through, etc) could be registered on the blockchain. Companies could even create and issue tokens to provide an incentive for 3rd party individuals/institutions to verify the authenticity of the information before it is registered on the blockchain.

Blockchain technology is the ideal solution to not only help companies save money, generate additional revenue or improve their internal processes, but also comply with regulations that require more transparency and accountability.

By comparison, governments require Banks to comply with strict KYC and AML processes that can cost as much as $60 million annually.

If a bank  wanted to adopt a faster payments solution using tokens administered on a public blockchain and stored in digital wallets, they would be at odds with regulators over the potential for customers to circumvent the the KYC and AML laws by making private transactions.

Even in the case of private consortium blockchains like Ripple, the questionable utility of their tokens has led to lawsuits over claims that they have been administering unregistered securities.

Ultimately, the reason why the supply chain industry has a much smoother regulatory path to adoption is simply because regulators and supply chain businesses are more aligned in their interests.

Technology Requirements

The third component is the sophistication of the technology needed to disrupt the current system. Blockchain financial services require the perfect combination of speed, security, and decentralization in order to compete with the current banking system. The challenge of achieving this perfect combination is called the ‘Scalability Trilemma’, and has been discussed in great detail by ethereum founder Vitalik Buterin. Although all blockchains are currently hindered by this fundamental problem of scalability, blockchains that seek to disrupt the finance space are most handicapped by their inability to guarantee security, speed and decentralization when billions of dollars are put at risk.  This demand for technical maturity puts way more stress on the system and requires much more sophistication than can be provided by blockchain technology in its current state.

The supply chain industry is minimizing the scalability problem by implementing private consortium blockchains.

These blockchains lower the risk of sensitive data leakage, while also enabling the technology to perform much more efficiently and scale faster due to a controlled number of users and transactions.

Although finance blockchains can also be private, they still have to contend with operating a security system that is not Byzantine fault tolerant, and demand a reliance on the handful of business that are running the network. When the primary asset at stake is actual money, as opposed to commodities, we can assume the risk is higher.

Customer Switching Costs

The fourth component is customer-switching costs, or more specifically, the capacity to convince customers and business to switch from traditional financial services to decentralized finance applications.

In developed nations, where the financial system and monetary policies are considered to be highly functional and mature, people are more content with the financial infrastructure.

For these users, making the transition to decentralized fintech applications would primarily be about convenience versus necessity.

In developing countries, where the local currency is highly inflated and people have limited to no access to banks or payment services, the demand for  blockchain based financial services is much higher.

However, the countries that tend to have the poorest monetary systems also have the most oppressive governments, which in the short term makes blockchain based financial services more difficult to adopt because of restrictive regulations.

The customer switching costs for supply chains are largely influenced by regulations, cost-benefit analysis, and customer service improvements.

As outlined above, blockchains provide transparency and efficiency to the supply chain process, which are mutually beneficial for regulators and supply chain businesses.  According to IBM, global trade volumes could increase by 15 percent through the use of  blockchain technology in the supply chain process. Samsung also believes they can cut their global shipping costs by 20% using blockchain technology.

Lastly, enterprise and regular customers benefit in their own way through the use of blockchain technology for supply chains. Enterprises reduce costs, save time and increase transparency. Consumers who shop for food items at a grocery store will be able to see details about a specific items journey from the farm to the store, and will also be able to ship items for cheaper due to the cost savings created by a more efficient supply chain process.

Market leaders in these industries may be more open to embracing blockchain technology, as it posses less of a conflict of interest.

For the financial industry, the conflict of interest is much greater, as a decentralized model takes the power away from central authorities that have traditionally dictated monetary policy, and exploited the lack of competition by charging high interest rates and limiting access to loans for poorer consumers.

Banks and financial services are currently adopting blockchain technology in a limited capacity, preferring to use private blockchains that save them money internally, but don’t necessarily provide the same added value to customers that a public blockchain using token economic models would provide.

On the consumer side, traditional financial service users have to be re-educated about the fundamentals of money, and why cryptocurrencies are a better alternative. In the supply chain, accounting and digital rights management industries, it is mostly businesses that are being educated about blockchain and cryptocurrencies, which should lead to faster adoption.

Conclusion

Despite the regulatory, technical and consumer adoption challenges, some still argue that the concentration of developer talent working on blockchains for finance is enough to guarantee that finance will be the first place to adopt blockchain technology at a mass scale.

We’ve seen similar arguments for the ethereum blockchain maintaining the top spot over competitors like EOS or ICON.  Although several of these “ethereum killers” offer higher transaction speeds, what many people discount is the size of the development community that ethereum has amassed over the years. Most sophisticated investors know that the future value of any technology is largely dependent on how many talented developers are willing to work on it.

Blockchain for finance is no different. Developers are currently rushing to where the money is, and clearly the big money is in the finance space.

Whether a vibrant community of tech talent will be enough to overcome government regulation and competition from multi-century old banking institutions remains to be seen. However if one thing is clear, it’s that we shouldn’t overlook other industries that may have the right amount of regulatory leeway, limited scaling challenges and consumer interest to sweep over the finance industry and establish themselves at the forefront of blockchain adoption.