ERP Resources: What is Blockchain?

This is the seventh of a series of articles on 'technologies for the coming decade that I am writing in my blog. I intend to cover 21 technologies / ideas. Here is my publishing history.

Introduction to Blockchain

Let us look at a scenario where four people are sitting at their home and playing a game over Zoom. The game is simple. Each participant will issue a virtual coin worth 1000 rupees into the game. Once every player has deposited the coins, a lottery identifies the winner who takes home all the four coins. The other participants transfer 1000 rupees each into her bank account.

There is no central authority monitoring this game. Each participant maintains a sequential record of all the transactions in the game. If anyone wants to manipulate the game (they want to say they added currency without actually adding it, for example), then they have to update the records maintained by all the four participants.

Each individual transaction as well as the sequence of transactions is transparent. There is no central authority to control and monitor. Everyone knows that Bhavana released her virtual coin after Anita did and Cindy followed Bhavana and that Dia won the lottery. Everyone agrees that the game is fair. Every participant trusts the results because the game is transparent.

Distributed data, lack of central monitoring (decentralized trust), transparency of transactions, consensus, security, traceability....

Friends, I give you Blockchain.

Definition of Blockchain

As per Blockchain Council, Blockchain is digital, decentralized technology, which maintains a record of all the transactions that happen over a peer-to-peer network. These records are stored in decentralized systems that are interconnected.

In simple words, Blockchain is a digital database, also called a 'ledger of transactions'. A network of computers verifies each transactions and then groups similar transactions into 'Digital Block'. Latest encryption technology is used to encrypt this 'block'. The last step is to link this block to the Blockchain. When added to the chain, this block not only holds the transaction information, it also holds the information about the previous block in the chain.

As you can see, Blockchain uses a single ledger, and this feature makes it simple and flatter.

How does Blockchain Work?

The diagram below explains the working of Blockchain at a high level.

The process starts when someone requests a new transaction. A Peer-to-Peer network (P2P Network), which is a network of computers each of which is a 'node', picks up this transaction and verifies it. P2P network verifies two things, the details of the transactions and the status of the user who created this transaction.

After an algorithm verifies the transaction, the transaction is bundled with other similar transactions to create a 'Block'. The algorithm attaches this block to the Blockchain. This latest block contains information that links it with the previous transaction in the chain. This connectivity makes the block of information permanent and immutable (unchangeable).

This completes the transaction.

Four Characteristics / Attributes of Blockchain

First attribute is Consensus. Before adding a new block to the chain (adding a new transaction to the chain) majority of participants (nodes) in the block chain must verify and approve. This ensures consensus across the participants in the chain.

Next attribute is data security. Blockchain data is immutable. It is impossible to modify data entered in a chain since the system uses Cryptographic Hash Functions (SHA-256). While I do not want to go deeper into the technology, in simple terms, Hash Function converts every input into a 256 bits long output. This immutability is the power of Blockchain.

In addition, three more security features make Blockchain secure.

One is that it requires 51% of participants to agree to modify any transaction. This is not feasible to achieve. In addition, the feature of 'decentralized data base' means that any modification in one block must update that block in all the user instances of the decentralized database. Finally, since there is a link between a block and its previous one, modifying data in any block means modifying the entire Blockchain in all the user instances.

Provenance is the third attribute. One benefit of linking every block in the chain is that traceability becomes extensible upstream till the start of the chain. This way Blockchain ensures end-to-end traceability (Global Traceability). This feature is very useful in many industries, especially Pharma and Food Processing Industries.

One of the key benefits of Blockchain is that it leads to distributed trust. Every node in the chain is responsible for building trust. Decentralized trust means that you do not have to depend on certifications from a single authority.

Why Blockchain

As per McKinsey, Blockchain has not been able to move beyond pioneering stage of a Product Life Cycle. There are simpler technologies available that can handle most of the Blockchain use cases. The section 'Challenges of Blockchain' below discusses a few more reasons.

So why are customers adopting Blockchain? Customers are adopting Blockchain because it provides three different values to the customers.

Some companies adopt Blockchain because it supports niche solutions that add real value. There are tried and tested niche solutions in Banking and Insurance industries where Blockchain is the best fit. Same is the case with FMCG industries especially esoteric products with discerning customers. For example, the producers of exotic wines are using Blockchain to expose the provenance of the ingredients to their customers by having the customers as a node in the chain.

Other companies use Blockchain as a starting point in their digital strategy. Their digital transformation begins with small Blockchain initiatives.

A few companies want to showcase Blockchain to their shareholders as a 'proof of intent' to invest in digitization and technology. In these cases, Blockchain may stay at a POC stage.

Benefits of Blockchain

A key benefit is the increased transparency and trust in transactions. Since every participant in the chain has visibility to all the transactions in the chain, it builds transparency and trust in the process

Since any act of fraud will need support from 51% or more of the participants and that is difficult to achieve. Blockchain design helps reduce fraud. This also leads to trust in the process.

Blockchain leads to reduction in transaction layers and the necessary oversight to monitor those layers. Less oversight leads to lowering of oversight costs. Flatter layers also lead to faster transaction processing.

Another benefit of Blockchain is that it enables fractional ownership. This helps consolidation of fractional assets to a larger asset blocks.

Since Blockchain is a technology built on distributed trust, it works best in a low trust environment by building trust

Faster transactions process is another benefit of Blockchain

Finally, the Provenance attribute of Blockchain ensures Global Traceability. Tracing of transactions up and down the chain becomes easy

Challenges of Blockchain

The initial investment in Blockchain is a challenge. Since the chain could potentially help their competitors, companies may be reluctant to make large investments in Blockchain, especially if it involves their competitors.

Yet another challenge is data sharing. Being in a Blockchain means exposing one's data to other participants in the chain some of who may be competitors. Companies will not want that level of data exposure.

One more challenge is that the other technologies are rapidly evolving and simpler options to replace Blockchain are appearing all the time. For example, many Banks are moving out of Blockchain to simpler and cheaper payment gateways that meet their transactional requirements of speed and trust.

Since Blockchain will reduce transactional layers, there is a fear of job losses, which is generating resistance to its wider adoption.

A technical challenge is that since each node must contain details of all the transactions, the capacity of the chain is constrained by the number of transactions that a single node in the chain can handle.

The concept of 'Decentralized Trust' means that the certifying authorities may feel loss of power (centralized trust) and those powerful agencies may resist the adoption.

Business Use Cases

1. Smart Contracts: This is the ubiquitous Blockchain use cases. It refers to conditional contracts with multiple options that are triggered by different events tracked using Blockchain.

2. Tracking the provenance of products: Customers want to be sure that the production is ethical and do not employ of child labour or use bad working conditions. In some cases, customers use Blockchain for Global Traceability. Providing customers with access to the Blockchain addresses these concerns.

3. Tamper proof online voting is one of the most promising use cases of Blockchain. By verifying the voter details and the voting transaction, Blockchain can make voting, extensive, inclusive, easy and tamper-proof.

4. By storing patient's data on secure Blockchain, doctors can easily access the data and improve the quality of healthcare. The potential is explosive when the patient is fitted with IIOT enabled devices.

5. Land records, confirmation of ownership and transactions: By putting land records on Blockchain, governments can protect property ownership

6. Consolidation of smaller landholdings to larger land banks to generate economies of scale in agriculture. Small holding on Blockchain will not only protect ownership as mentioned in point five above, it will also ensure equitable distribution of profits from sale of agri produces.

7. Food is another promising use case of Blockchain. Farm origination details stored in Blockchain can improve transparency and trust.

8. Smart metering of energy is another use case. Blockchain can smooth transactions in the energy market by enabling a small householder sell the excess solar energy he produces into the grid. Blockchain enables tracking and payments at a micro-unit level.

References

ERP Resources

GDPR Declaration !!

Monday, January 11, 2021

What is Blockchain?

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