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Peter Borovykh

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Saturday, June 17, 2017 - 9:44am

The business world is still trying to figure out the best uses of blockchain. Despite relative popularity in the press, the examples of potential cases for blockchain integration are limited at best currently.

In order to create more blockchain opportunities, we need to look at what blockchain is and what industries can be most affected by it. Let’s look at a classic example of how blockchain works.

Alice wants to send a transaction to Bob. Alice sends her transaction to the blockchain network where Carl, Cindy, and Chris validate Alice’s transaction using computational powers of their computers. Once the transaction is authenticated, it goes to Bob. Thus, the concept of blockchain is at a three-way intersection of the following sectors:

  • Technology: Faster computational and processing powers improves safety and trustworthiness of the network.

  • Energy: Cheaper and more available sources of electricity (energy) make the job of miners more economic, attracting more validators to the network.

  • Finance: Migration of financial transactions onto blockchain turns it into a self-sustainable mechanism.

It is fair to say that lots of other business areas could be included in the list above. However, in this article I would like to go through these three sectors and ruminate about some of the potential trends resulting from deeper blockchain penetration.

Consensus Conference 2017 featured two companies that perfectly depict the evolution story of blockchain in the world of finance: GigaWatt and Fidelity. I had a chance to speak with the former and watch the presentation of the latter, which inspired me to look deeper into the matter and conduct appropriate analysis.

Mining Hubs, Alternative Energy & Faster Computers

I spent nearly half an hour at GigaWatt’s booth talking to their head of sales, Hayden Gill. Located in the State of Washington, GigaWatt is one of the top players in the mining space, offering full-service mining solutions. We spoke about the main challenges and opportunities faced by the miners all over the world.

Miners in the proof-of-work blockchains use computational powers of their machines to connect to the blockchain network, authenticate every transaction, construct and record all the historical blocks, and agree on which blocks are to be added to the blockchain ledger.

There are several problems faced by each individual miner.

  • First of all, the computational power of the network is constantly increasing, forcing the miner to either join a network of other miners or constantly upgrade their own computational power.

  • Secondly, mining requires enormous amounts of electricity. Every additional miner to the network increases the amount of operations and power that needs to be spent to keep it running.

  • Lastly, while processing data the machines heat up and need to be cooled down, thus requiring additional cooling power.

There are also some problems faced by the entire network. Blockchain is especially notable for the distributed structure of its nodes or miners. In a perfect world where miners are not familiar or affiliated with one another and where the space containing miners is fully frictionless, the existing architecture of blockchain is, in fact, distributed. However, we live in an imperfect world, which is divided into regions with different jurisdictions and regulations. On top of that, individual miners and groups of miners are seeking to take advantage of any imperfection in the system.

Certain geographical regions have a number of advantages including cheaper electricity, cooler climate, lower taxes, or more sophisticated mining ecosystem, drastically reducing mining costs and increasing chances to influence the network.

For example, according to the recent Bitcoin Worldwide article the majority of Bitcoin mining pools are located in China, which is known for cheap electricity and impressive computational capacities. Some of the other countries featuring Bitcoin mining hubs include Czech Republic, Georgia, Iceland, Sweden, and the United States. It is pretty obvious that the blockchain network is far from perfectly distributed worldwide, with certain clusters potentially having more voting power and, thus, potential influence on the whole network.

Based on all of the aforementioned information, our analysis points to four major trends.

Trend 1: Integration of private enterprises into virtual networks

U.K. Ministry of Defense forecasts that individuals will have a tendency to define themselves less by their nationality, but rather with “stronger links to virtual communities”. In addition, the same report emphasizes that private and non-state entities might become primary providers of those services that states have traditionally delivered due to “rising costs, demands, technical complexity and need for specialization”. We will also see a shift to alternative currencies from state-backed entities, which will be the “dominant form of money in 2045”. Private enterprises must heavily integrate and partner with virtual communities and commercialize consumers by solving their problems.

Trend 2: Hosting on mining pool servers

To successfully communicate with virtual networks, private enterprises must enable operations in cryptocurrencies utilizing public blockchains. To be fully represented on the network, companies will have to either be involved in mining directly or purchase hosting on the servers of mining pools.

Successful regional hubs must have five characteristics:

  • Cheap electricity

  • Cool climate

  • Developed technological ecosystem

  • Favorable jurisdiction to international investors

  • Optimal tax system

Further corporate integration of public blockchains and need for stability and security as well as operational efficiency will likely move mining pools away from China and into the Nordic and Baltic regions that have all of the aforementioned factors in place. Russia might become the mining hub for ex-Soviet Union states, while northern parts of Canada for NAFTA members. Emerging economies, including Mexico, Indonesia, Turkey, Nigeria, and Vietnam are also likely to become regional mining hubs due to cheaper energy costs.

Trend 3: Private enterprises compete with oil cartels

More sophisticated technology and more distributed global network of miners will require cheaper sources of energy. U.K. Ministry of Defense expects that in the 2045 timeframe, “coal and hydrocarbons are likely to remain the most important sources of energy, with renewable and nuclear energy likely to make an increasing contribution”. Yet the demand for resources of all kinds will keep rising given the world’s growing population.

It will be in the interest of private enterprises to make virtual communities more efficient, and heavy investments in development of alternative sources of energy can be anticipated. Corporation consortiums might become involved in uneasy fights with oil cartels to discover and promote new energy sources.

Trend 4: Moore’s Law is revived

High computational-intensity of public blockchain networks will require continuous growth in the power of computer chips. Moore’s Law, formulated by Intel co-founder Gordon Moore, claims that the number of transistors per square inch on integrated circuits had doubled every year since their invention, and this trend will continue. At the International Solid-State Circuits Conference last year, Intel’s technology and manufacturing group leader mentioned that Intel will have to use fundamentally new technologies to keep improving the chips.

Many technology sources expect Moore’s Law to run out of steam by the 2020s. With private enterprises incentivized to increase processing powers to capitalize on blockchain networks, heavy investing into technology space is foreseen. This will cause Moore’s Law to likely remain correct into the 2020s.

Blockchain Solves the Problem of Global Economic Growth

The majority of sources talk about banking for the “unbanked”, optimizing infrastructure costs for the big investment banks, and cutting down financial fees for consumers.

According to the DeNovo Q2 2016 FinTech Recap and Funding Review, PwC emphasizes that 2 billion of “un(der)banked individuals” present the largest opportunity for FinTech. Banking on Blockchain by Accenture estimates $10 billion of annual cost savings for investment banks. The Capgemini report titled Smart Contracts in Financial Services: Getting from Hype to Reality believes that consumers could save up to $16 billion in banking and insurance fees.

Our internal research aligns with aforementioned conclusions, but we believe the cases for blockchain implementation lie far above optimizing expenses or providing banking to strategically important, yet not the most lucrative, segment of unbanked individuals. We believe blockchain technology could be instrumental in triggering continuing future economic growth for the entire world.

I was able to attend the presentation by Fidelity’s chair and CEO, Abigail Johnson at the Consensus Conference 2017. Her speech was very positive in regards to the future of blockchain. She identified a number of problems faced by existing public blockchain systems, including an imperfect state of security, a lack of regulatory framework, and privacy issues. What was truly staggering to learn is that Fidelity experimented with actual mining of Bitcoins. Let’s connect that point to the global trends.

Remember from the first section that virtual communities will slowly become more important than national identity? Similarly, alternative currencies will assume a larger market share, coexisting with state-backed currencies. Non-state actors will evolve to replace governments in providing a variety of services.

National Intelligence Council sees the world going through a major diffusion of power by 2030. Their report says that communication technologies will shift power toward “multifaceted and amorphous networks that will form to influence state and global actions”. The Group of 30 conducted very profound and insightful research on the future of global economic growth. Its Long-term Finance and Economic Growth report emphasizes that the “demand for long-term investment is projected to rise substantially as mature economies address long-deferred infrastructure needs and emerging nations continue to urbanize and industrialize”.

U.K. Ministry of Defense expects that “countries may be more closely connected, with stronger trading and political blocs.” What are some of the trends that blockchain technology could capitalize on? Let’s add a couple of other very important trends to answer that.

Trend 5: Corporate ICOs

The need for tighter integration with virtual communities incites private enterprises to not only mine the cryptocurrency of public blockchains, but also launch its own coins. By taking some of the state responsibilities on their own shoulders, corporations will have to play a greater role in shaping the global financial system and have to be compensated for doing so; thus, making governments “less able (…) to raise revenues through taxation”. Alternative currencies will slowly attain more characteristics of money, and corporate crypto-coins will serve as a medium of exchange with the virtual networks.

The desperate need for solutions associated with stronger processing power and cheaper energy will lead towards smoother trading and political international relationships. Corporations will take a more proactive role in driving technological progress via heavy cross-border investing and diverse partnerships. The shift from paper money to electronic money will be as close as it can be.

Trend 6: Turning global savings into global progress

Group of 30 forecasts that by 2020, “nine major economies will need to invest an additional $7 trillion annually to support [global economic] growth”. If $7 trillion does not sound impressive, let’s put it into perspective. According to the World Bank data, the world GDP in 2015 was $74 trillion. Therefore, the world needs an additional 10% of today’s world GDP just to continue its economic growth.

But what about the 2 billion (or 2.5 billion based on other sources) of unbanked or underbanked individuals? The report by PwC claims that they represent payment opportunities in the amount of $3 trillion and an unmet deposit demand of at least $360 billion. The unbanked is a huge opportunity, indeed, but not the major one. The Group of 30 report fairly pinpoints that the problem of future global growth exists due to the lack of global savings. Thus, the required $7 trillion of global savings that will need to be channeled through deposits from the already banked exceeds the unbanked opportunity by almost 20 times.

The Group of 30 report emphasizes that the core function of the financial system lies in the  “matching of global savings with long-term investment opportunities”. The institution lists the top four principles needed to solve the problem of global growth, and it is surprising how all of these principles align perfectly with blockchain technology. In other words, blockchain can solve the main world problem miraculously well through a robust system of strategic smart contracts and relevant international regulatory framework.

Finally, Group of 30 acknowledges that potential long-term investors are “constrained in their ability to provide financing”. The report mentions that pension funds, sovereign wealth funds, insurance companies, endowments and foundations are “ideal candidates to provide long-term financing”, but the barriers such as “incentives and restrictions on portfolio allocations” need to be addressed. I consider the Fidelity experiments with mining Bitcoins not as innocent as they might appear. The financial giant realizes the problem and recognizes blockchain as one of its most efficient solutions.

Trend 7: Stronger trading and political blocks

Countries will have to take a more collaborative approach to form stronger trading and political blocs. On top of the existing coordinate plane with country borders, a new plane with corporation borders will become even more pronounced. It will be in the interest of the world community to work together on international legal and regulatory frameworks to allow private enterprises take on more responsibilities.

The Group of 30 report points out that “bank lending provides the majority of financing in most ([emerging]) economies”. But regional bank lending does not solve the problem of long-term financing, since “commercial bank loan maturities average only 2.8 years in emerging economies and 4.2 years in developed economies”. Frictionless cross-border flows of capital and talent is required to spur global growth. More foreign-trade and visa-free zones are to be expected. Aside from the technological solutions provided by blockchain networks, the smart contracts will have to include special provisions accounting for regional jurisdictions incentivizing corporations to enter new emerging markets.

Trend 8: Wall Street is back, but this time it is global

The rise of Wall Street in the United States was mainly due to sophisticated financial instruments and favorable state regulations that worked together to provide great investment opportunities for investors all over the world. The fact of the matter is that such opportunities can be found in many economic regions; however, the lack of expertise, talent, and regulatory framework coupled with political risks prevent the development of regional capital markets. Group of 30 analysis claims that “prudent growth of new bond, securitization, and equity markets, adequately overseen and supervised, must be part of the solution to the long-term finance problem”.

With the ability to strike all kinds of financial agreements over the blockchain network, emerging economies will receive a very much needed breath of fresh capital inflows. Wall Street will revive itself, but this time it is going to be more diverse, more regulated, more technological, and more global. Moreover, both institutional and retail investors will have a chance to take advantage of investment opportunities with various risk-reward profiles. This will make global investing more diversified and, perhaps, minimize economic drawdowns. It does not mean that recessions will be eradicated. In fact, initial stages of blockchain penetration might feature severe and painful downsides. However, those financial institutions who take advantage of blockchain early on will become leaders responsible for shaping the world of finance.

Short Summary

Blockchain is a unique and exciting combination of Energy, Technology and Finance, and all three sectors are likely to see enormous inflows of investors in the attempt to solve many problems humanity will face in the years to come.

As a blockchain solution architect, I love analyzing blockchain and its uses. If you’d like to discuss blockchain or fintech at length contact me at Blockchain Driven.

Peter made his name in finance and later became fascinated with the digital applications of blockchain in his field. He is a quant who has created his own groundbreaking algorithmic trading strategies based on quantifying the market sentiment and leveraging the emotion of market participants. Peter is a renowned speaker on blockchain and its future possibilities. He is a solution architect at BlockchainDriven.com and is currently finishing his book “Blockchain Applications in Finance”.