Blockchain’s Occam problem

 

Here is a brief excerpt from an article written by Matt Higginson, Marie-Claude Nadeau, and Kausik Rajgopal for the McKinsey Quarterly, published by McKinsey & Company. To read the complete article, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.

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Blockchain has yet to become the game-changer some expected. A key to finding the value is to apply the technology only when it is the simplest solution available.
Blockchain over recent years has been extolled as a revolution in business technology. In the nine years since its launch, companies, regulators, and financial technologists have spent countless hours exploring its potential. The resulting innovations have started to reshape business processes, particularly in accounting and transactions.Amid intense experimentation, industries from financial services to healthcare and the arts have identified more than 100 blockchain use cases. These range from new land registries, to KYC applications and smart contracts that enable actions from product processing to share trading. The most impressive results have seen blockchains used to store information, cut out intermediaries, and enable greater coordination between companies, for example in relation to data standards.One sign of blockchain’s perceived potential is the large investments being made. Venture-capital funding for blockchain startups reached $1 billion in 2017. IBM has invested more than $200 million in a blockchain-powered data-sharing solution for the Internet of Things, and Google has reportedly been working with blockchains since 2016. The financial industry spends around $1.7 billion annually on experimentation.There is a clear sense that blockchain is a potential game-changer. However, there are also emerging doubts. A particular concern, given the amount of money and time spent, is that little of substance has been achieved. Of the many use cases, a large number are still at the idea stage, while others are in development but with no output. The bottom line is that despite billions of dollars of investment, and nearly as many headlines, evidence for a practical scalable use for blockchain is thin on the ground.

Infant technology

From an economic theory perspective, the stuttering blockchain development path is not entirely surprising. It is an infant technology that is relatively unstable, expensive, and complex. It is also unregulated and selectively distrusted. Classic lifecycle theory suggests the evolution of any industry or product can be divided into four stages: pioneering, growth, maturity, and decline (exhibit). Stage 1 is when the industry is getting started, or a particular product is brought to market. This is ahead of proven demand and often before the technology has been fully tested. Sales tend to be low and return on investment is negative. Stage 2 is when demand begins to accelerate, the market expands and the industry or product “takes off.”

Across its many applications, blockchain arguably remains stuck at stage 1 in the lifecycle (with a few exceptions). The vast majority of proofs of concept (POCs) are in pioneering mode (or being wound up) and many projects have failed to get to Series C funding rounds.

One reason for the lack of progress is the emergence of competing technologies. In payments, for example, it makes sense that a shared ledger could replace the current highly intermediated system. However, blockchains are not the only game in town. Numerous fintechs are disrupting the value chain. Of nearly $12 billion invested in US fintechs last year, 60 percent was focused on payments and lending. SWIFT’s global payments innovation initiative (GPI), meanwhile, is addressing initial pain points through higher transaction speeds and increased transparency, building on bank collaboration.

Blockchain players in the payments segment, such as Ripple, are increasingly partnering with nonbank payments providers, the businesses of which may be a better fit for blockchain technology. These companies may also be willing to move forward more rapidly with integration.

In addition, the payments industry faces a classic innovator’s dilemma: incumbents understand that investing in disruption, and the likely resulting rise in customer expectations for faster, easier, and cheaper services, may lead to cannibalization of their own revenues.

Given the range of alternative payments solutions and the disincentives to investment by incumbents, the question is not whether blockchain technology can provide an alternative, but whether it needs to? Occam’s razor is the problem-solving principle that the simplest solution tends to be the best. On that basis blockchain’s payments use cases may be the wrong answer.

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Conceptually, blockchain has the potential to revolutionize business processes in industries from banking and insurance to shipping and healthcare. Still, the technology has not yet seen a significant application at scale, and it faces structural challenges, including resolving the innovator’s dilemma. Some industries are already downgrading their expectations (vendors have a role to play there), and we expect further “doses of realism” as experimentation continues.

Companies set on taking blockchain forward must adapt their strategic playbooks, honestly review the advantages over more conventional solutions, and embrace a more hard-headed commercial approach. They should be quick to abandon applications where there is no incremental value. In many industries, the necessary collaboration may best be undertaken with reference to the ecosystems starting to reshape digital commerce. If they can do all that, and be patient, blockchain may still emerge as Occam’s right answer.

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Here is a direct link to the complete article.

Matt Higginson is a partner in McKinsey’s Boston office, Marie-Claude Nadeau is a partner in the San Francisco office, and Kausik Rajgopal is a senior partner in the Silicon Valley office.

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