Beyond Bitcoin: Get to Know the Tech Behind Cryptocurrencies That Has Businesses Buzzing

Newswise — As the value of the cryptocurrency bitcoin surged on an exponential curve last winter, investors, the media and even the general public were swept up in a mania that many compared to a modern day Dutch tulip bubble.

The New York Times wrote of early bitcoin investors-turned-billionaires buying up large swaths of San Juan, Puerto Rico, in the wake of Hurricane Maria in an effort to found a crypto-utopia. John Oliver dedicated an episode of his HBO show Last Week Tonight to satirize a Wild West industry of “initial coin offerings” underscored by a lack of regulation, irrational decision-making and collusion that would make the Securities Exchange Commission’s Division of Enforcement blush. Through it all, more than one University of Virginia Darden School of Business finance professor remained skeptical of the real underlying value of any cryptocurrency.

But underneath all of these cryptocurrencies is a technology many industry experts and leading corporations from JPMorgan Chase to IBM believe has tremendous potential: blockchain.

What is Blockchain?

For more than 7,000 years, humankind has used ledgers to record economic transactions. Archaeologists say clay tablets were used in ancient Mesopotamia to record simple purchases and sales of basic goods, growth of herd sizes and more.

The world has come a long way since clay tablets, though. Modern computing has transformed basic financial ledgers into lightning-fast, highly automated, precisely accurate relational databases. Today, as cybersecurity and transparency emerge as paramount priorities during digital transactions, blockchain technology has the potential to be the next generational improvement in how parties record the exchange of value.

In its most abstract sense, blockchain is a new platform technology enabling an improved ability to verify and record the exchange of value among an interconnected set of users. It is a secure and transparent way to track the ownership of assets before, during and after any transaction.

Each transaction between parties in the network is a “block,” and the cumulative set of transactions across the entire network is the “chain.” Blockchain. The technology enables any network of users to track and trade virtually anything of value.

Broadly speaking, there are currently two types of blockchains: public and private.

Public blockchains are open to anyone, and each use their own digital, “native currencies” (e.g., bitcoin). These native currencies are the required mediums of exchange in order to use the public blockchains to exchange value. Native currencies are needed for two reasons: to compensate network members who verify transactions (called miners) and, given the anonymous or pseudonymous nature of network members, to claim an underlying asset from its issuer.

A private — or “enterprise” or “permissioned” — blockchain also records the exchange of value between parties in a network, but access to the network is permissioned and not everyone can join it. It is worth noting that since all parties are known to each other in a private blockchain, a native currency like bitcoin is not needed. In general, while specific applications of blockchain technology are still developing, there is a growing consensus that blockchains offer several benefits compared to legacy ledger technologies:

• Everyone in the network has an identical copy of the ledger.
• Network rules are democratic and voted on by members.
• Cryptography protects all data.
• Digital keys are needed to access transaction records.
• The ledger is permanent and tamper-resistant.
• The ledger reflects new transactions in near-real time.
• “Smart contracts” are possible with blockchain.

These benefits enable the development of many potential products and applications for industry.

Examples of Blockchain Applications

In practice today, most current blockchain products and applications fall into three buckets.

1. Operational Functions in Financial Institutions

Financial services institutions expect blockchain to yield operational benefits related to cross-border payments, given reduced transaction, administrative and capital costs; shorter settlement times; and fewer errors, according to Accenture Digital. Asset managers, for example, will also be able to use blockchain for client onboarding, management of model portfolios, trade and order management, regulatory and compliance reporting, real asset transactions, and data management.

2. Operational Functions in Other Industries

Blockchain applications apply to nonfinancial services industries, too. There are potential applications across enterprises in the consumer packaged goods, government and technology industries, including customer loyalty programs; tax, benefit collection and distribution; medical record keeping; inventory controls; and supply chain management.

3. Smart contracts

Smart contracts are a type of blockchain transaction that can be thought of as event-triggered, automated pieces of computer code. They can be as simple as “ship the product when we receive the payment” or “distribute dividends to shareholders upon their declaration.” All smart contract transactions are stored on a blockchain, which provides both an audit trail of events and assurance of fulfillment of contract terms.

Blockchain has the potential to deliver operational cost savings and improvements, better customer experiences, and more seamless interactions between enterprises and customers.

There is growing interest in blockchain across diverse industries, and industry leaders have deployed teams of experts to work on how to use it. However, some experts are skeptical that blockchain technology will find a broader home in industry, arguing that transaction ledgers can be easily expressed as relational databases, with current best-in-class database tools more than sufficient for most needs.

Views of Regulators

When novel technologies with applications in financial services appear to gather critical mass, regulation follows. The current focus of legislators and central banks appears to be around payments, clearing and settlements. This focus appears to makes sense, too: U.S. payment, clearing and settlement systems process about 600 million transactions per day, valued at over $12.6 trillion, according to the Federal Reserve’s Division of Research & Statistics.

The Fed believes that “[blockchain] may represent the most significant development in many years in payments, clearing, and settlement.”

There is also the question of whether or how digital “currency” regulations will trickle down to affect blockchain use, and there appears to be regulatory interest connected to how people will ultimately use digital currencies.

Considerations for the Future

At present, blockchain is a relatively nascent technology that appears to offer valuable product and service applications. Leaders whose businesses might evolve from technological advances need to decide: should they determine how to use the technology and pursue those opportunities, or should they wait until others try it, see how they do and learn from their mistakes?

The urgency of this decision may vary depending on industry.

Financial services companies may evolve sooner than others. Industries that feature complicated global supply chains, have high degrees of intermediated global payments, require high levels of data security and whose transactions face strong degrees of regulatory scrutiny may be motivated to adopt and deploy blockchain within individual enterprises.

If blockchain can deliver products and services that improve the customer experience and the profitability of an enterprise, the organizations that use it may capture a larger, more profitable share of a competitive marketplace moving forward.

Aaron Fernstrom (GEMBA ’15) is associate director of Darden’s Richard A. Mayo Center for Asset Management and co-wrote the top-selling Darden Business Publishing case “Bitcoin: Investment or Illusion?” with Professor Yiorgos Allayannis.