It’s Time to Take Another Look at Blockchain

It wasn’t long after the developers of bitcoin first used a distributed ledger to record transactions in 2008 that the blockchain revolution was announced with all the fanfare that usually accompanies promising new technologies. Then, as often happens with emerging technologies, blockchain’s promise collided with developmental realities.

Now, a decade and a half down the road, that early promise is becoming manifest. In his new book, Enterprise Strategy for Blockchain: Lessons in Disruption From Fintech, Supply Chains, and Consumer Industries, Ravi Sarathy, professor of strategy and international business at the D’Amore-McKim School of Business at Northeastern University, argues that distributed ledger technology has matured to the point of enabling a host of applications that could disrupt industries as diverse as manufacturing, medicine, and media.

Sarathy spoke with Ted Kinni, senior contributing editor of MIT Sloan Management Review, about the state of blockchain, the applications that are most relevant now for large companies, and how their leaders can harness the technology before established and new competitors use it against them.

MIT Sloan Management Review: Blockchain has been slow to gain traction in many large companies. What’s holding it back?

Sarathy: Blockchain is a complex technology. It is often secured by an elaborate mathematical puzzle that is energy intensive and requires large investments in high-powered computing. This also limits the volume of transactions that can be processed easily, making it hard to use blockchain in a setting like credit card processing, which involves thousands of transactions a second. Interoperability is another technological challenge. You’ve got a lot of different protocols for running blockchains, so if you need to communicate with other blockchains, it creates points of weakness that can be hacked or otherwise fail.

Aside from the technological challenges, there is the issue of cost and benefit. Blockchain is not free, and it’s not an easy sell. It requires significant financial and human resources, and that’s a problem because it’s hard to convince CFOs and other top managers to give you a few million dollars and a few years to develop a blockchain application when they do not have clear estimates of expected returns or benefits.

Lastly, there are organizational challenges. A blockchain is intended to be a transparent, decentralized network in which everyone talks to each other without any intermediaries organized in a world of hierarchies. Making that transition can require a long philosophical and cultural leap for traditional companies used to a chain of command. Trust, too, becomes a huge issue, particularly when you start adding independent firms to a blockchain.

This sounds pretty daunting. Why should the leaders of large enterprises be considering blockchain now?

Sarathy: Over the past 15 years, computer scientists have been working continuously to improve the underlying technology, and while those obstacles haven’t been fully overcome, they’re certainly much lower than when blockchain was first introduced, and these barriers are becoming even lower. The cost-benefit problem can be overcome with a good process for pilot projects. The organizational problems depend on the company and its culture, but blockchain itself can serve as an engine for trust. Also, we’ve seen the development of permissioned blockchains, which enable companies to retain more control. These are all reasons why leaders who became disillusioned with blockchain early on might want to take a serious look at it now.

Blockchain is premised on distributed authority and decentralized control. Isn’t the idea of a permissioned or closed blockchain a contradiction in terms?

Sarathy: In a way, it is. The strength of a blockchain is that the majority of the nodes have to validate a transaction and that its tokens create an economic incentive to not cheat. By going to a permissioned blockchain, you’re reducing the number of nodes that participate in approving a transaction. So you’re creating more risk, and you could subvert confidence in the blockchain. But that’s a trade-off leaders need to consider.

Vitalik Buterin, the programmer who is a cofounder of Ethereum, first proposed the blockchain trilemma by asking, “How do you maximize speed, scalability, and security simultaneously?” Currently, one has to give in order for the other two to be improved. Leaders need to figure out how to balance the three qualities in the way that works best for their organizations.

As result, there are different flavors of blockchain — depending on the problems being solved and the number of parties that need to be involved in making decisions — and there are situations in which a permissioned blockchain could work quite well. For example, if the Federal Reserve used blockchain for managing financial transactions, it could say, “Well, we can restrict the number of nodes to only the systemically important financial institutions, maybe 100 or so.” By reducing the number of nodes, the Fed’s blockchain would feature high speed and scalability. And because the Fed would have full faith in the banks it included, trust would not be a major issue, although there’s always the risk that one of the included banks could be compromised by an ill-intentioned actor.

Lots of startups are building businesses around blockchain. Does that pose a strategic threat to incumbent companies?

Sarathy: Yes, because the whole idea behind blockchain is to do away with intermediaries. This creates a major risk for media companies like Spotify and consumer ratings companies like Experian. What happens to Spotify’s business model if musicians can interact directly with fans, or to Experian if consumers can control their own credit information and determine when, how, and to whom they will provide access, and on which terms? Incumbent intermediaries need to start learning how to use blockchain now. They can’t afford to wait and say, “Let’s see if this happens.”

How could a company like Spotify respond to a threat like that?

Sarathy: Its leaders might have to start thinking more about the needs of musicians and how the company can help them create content and establish themselves, because the margins associated with its transaction fees are likely to fall steeply. Spotify also might decide to go into the production business, which it has started to do with podcasts. By the way, the company is already exploring how it can streamline and bolster its business by using blockchain combined with NFTs [nonfungible tokens] to increase musicians’ revenue, while blockchain-verified identities can reduce its problems with free riders.

What are the most promising blockchain applications for incumbents at the moment?

Sarathy: One is supply chains. Maersk and IBM joined together to create TradeLens, which is a blockchain-based platform designed to create a single source of truth for international shipments. Shipping is a process that has been difficult, time-consuming, and subject to fraud. There are errors that cause disputes, and lost documents that cause hang-ups in customs and elsewhere. All the parties involved can get full visibility into a shipment on TradeLens. Transaction data is constantly updated so that counterparties know exactly where the shipment is and what stages it has passed through. You can even attach electronic bills of lading or letters of credit to it so that the banks become part of the blockchain and release payment when all of the terms of the contract have been met.

Another promising application is co-innovation and crowdsourcing. Ubisoft is experimenting with blockchain to facilitate decentralized video game development. In its Axie Infinity, game studio Sky Mavis allows players to build new environments and monsters, thus creating new challenges, and then charge other players a fee to access them. User-built video game assets can be traded as NFTs, earning tokens that can be converted on digital exchanges into cryptocurrencies or fiat money.

Where should leaders who are just getting started with blockchain be focusing their attention and efforts?

Sarathy: I think starting with an intraorganizational blockchain — as opposed to an interorganizational one that includes external partners — is a good idea. Internal applications are the low-hanging fruit of blockchain, because the data you’ll need is more accessible and there is a greater ability to require participation and maintain control of the blockchain. Think of internal audits. Companies need audits because they need to verify data, but blockchain, by providing an audit trail and assuring provenance, can ensure that the assets that are supposed to be there are actually there. The internal audit function probably won’t disappear entirely, because there may be some areas where you cannot completely rely on the blockchain, but it will make audits faster and reduce their cost. Speaking of disintermediation, consider the ramifications of that for big audit firms like PwC and Deloitte, which have developed blockchain applications such as Halo and Coinia to explore blockchain capabilities in auditing.

HR would be a very good internal application of blockchain. Every company needs to be able to track individuals, from recruitment to retirement — and sometimes beyond. Why was this person recruited? What was she promised, in what time frame? What are her deliverables, and were they achieved? Who will supervise her, and how are her evaluations? The answers to all these questions can be recorded within the blockchain, even as the person’s status is constantly changing based on her performance and evaluations and rewards. It’s secure, and you can create levels of access so that certain people can see certain things in certain time frames. It’s scalable to thousands or tens of thousands of people. You can get a very complete picture of an employee in one place anytime you want, and it can be a completely permissioned blockchain because it’s internal to the company.

You mentioned the cost-benefit challenge and the need for a good process. How should large enterprises approach blockchain?

Sarathy: The starting point is to understand where you can best leverage the features of blockchain. Create a list of blockchain attributes and determine whether there is good fit between those features and the use case you are considering. For instance, blockchain is usually ideal in situations where you need to have a lot of confidence in data that often changes. A use case in which you need to be able to track, share, and validate the data — and if somebody tries to tamper with the data, it’s highly evident — is a good fit.

A use case that would benefit from a smart contract is another example. If you have actions that require a certain sequence based on events that are actually carried out or triggered by a certain event or information, blockchain can be a good fit. So start by asking, “Does my use case need the unique capabilities of blockchain?”

Once you have a promising use case, what’s next?

Sarathy: Once you get approval, you have to run a pilot. That means choosing a protocol and creating the blockchain. This is where you learn about all the steps that go into blockchain. Maybe you hire a consultant to help with the architecture, but you won’t have to reinvent the wheel. There is off-the-shelf software or lots of open-source software in places like GitHub. Of course, there are some security issues surrounding exchanging data between the various modules.

Then comes a really interesting part, which is getting people on board. You need users, and that requires a certain amount of education and training, because people are going to be scared about moving to something new. You need to have champions from the top saying, “Hey, we support this, and we really want you on board.” You also should plan on running the blockchain in parallel with the legacy system for a while, because nobody is brave enough or foolhardy enough to say, “I’m going to move right from the legacy to the blockchain.”

After you’ve got the pilot running, it’s time to take stock. What is the user feedback? Are you accomplishing the goals of the pilot, and can we estimate the return on investment? You have to go back to the board and top management and present results. Sometimes the results may not be encouraging because of execution mistakes, and you need a do-over.

If a blockchain pilot is successful, what might the path forward look like?

Sarathy: Organizations should probably plan to go through phases with blockchain. Once you have a successful internal application, you might start thinking about expanding to an external application, which is a bit more complicated. That means thinking about things like interoperability.

At the end of the day, I see building an organizational capability for blockchain as an iterative cycle that might take two to three years as you go through two or three pilots that are gradually more complex and you gain confidence and lower resistance to change. Remember, you’ll need people with skills, like blockchain programmers who know specialized languages, project managers who have experience with blockchain, and CIOs who can prioritize and choose between multiple competing blockchain proposals. You have to build and nurture the capability.

Does blockchain eventually become a tool in the managerial toolbox?

Sarathy: It’s a tool, but it’s also a new way of running a business. Blockchain enables you to give people more autonomy and to create a more decentralized organization.

Blockchain can be used to incentivize behavior. Instead of having to manage and persuade people, you can use the incentive mechanism of tokens within the blockchain to encourage the employee behaviors and actions that you want. Game theory is about how humans behave, what kind of incentives they respond to, and how incentives can be programmed into the game. But economists have always talked about game theory in a very theoretical fashion. Blockchain makes it possible to bring game theory onto the shop floor and into the sales force. It can motivate and align employees.

How might something like that work?

Sarathy: Corporations have budgets and goals, and managers have to measure employee performance against them and put that into an evaluation. Then somebody links that evaluation to a score on a performance appraisal, and based on that, an employee gets a reward or a caution. A token-based incentive builds that idea into a smart contract on a blockchain. Depending on how someone performs, token awards can automatically be larger or smaller and can be allocated across teams. The smart contract defines the value of tokens, and they are redeemed for a raise or a promotion or time off. Such blockchain applications can fundamentally change the way in which people are managed.

I think companies will eventually launch a swarm of such blockchain innovations, try to work their way through various ideas, and test them in pilots, gradually narrowing down to those applications that are most promising.