A Blockchain Primer: What Is It, Who's Using It, When It'll Go Mainstream, And How To Invest In It
In 2008, a whitepaper was written by Satoshi Nakamoto (whoever he, she, or they may be), which ultimately introduced Bitcoin to the world. But as much as Bitcoin is truly revolutionary, it stands on the shoulders of a number of papers authored by Scott Stornetta and Stuart Haber in the early 1990s that outlined ways to digitally serialize, timestamp and protect transactions through a distributed, or decentralized, database. These papers effectively outline the framework for what has become known as blockchain technology. We’ve seen several ETFs come to market looking to capitalize on the explosive growth and disruption associated with blockchain and more than a few companies pivot their business models to capitalize on it as well.
But first, we'll give you a quick primer on blockchain, as well as some real-life examples, before getting into mainstream adoption and ways to invest in it.
What is Blockchain?
Here's a quick non-technical review of how bitcoin utilizes blockchain technology:
- A bitcoin transaction occurs
- Details of the transaction are published to the blockchain (a new “block”)
- The new block is replicated throughout the blockchain and participants work on verifying the information
- Once the block has been verified, it becomes a permanent record in the blockchain and those participants who completed the verification (“Miners”) are compensated (new bitcoins are generated)
While new blocks contain information about a particular transaction, it doesn’t exist in a vacuum. Each block is cryptographically linked to the block preceding it. This block to block connection is carried through each block requiring that a change in one be carried through not just that block but all subsequent entries.
Because verified blocks are part of a distributed network, the only way to falsify information is if the fraudster controls more than 50% of the network. This is known as a “51% Attack” and while improbable (but not impossible) in a public network as large as Bitcoin, an attack could easily be perpetrated in networks of smaller coins.
Bitcoin and other cryptocurrencies operate on public blockchains. Anyone who wants to verify transactions as a Miner can do so with just a computer and an internet connection. Whether they may be profitable or not, depends more and more on how much processing power they have and how much they pay for the electricity needed to power those processors. Blockchain supported cryptocurrencies like Bitcoin, Ether and even fan favorite Dogecoin have been dominating headlines for just about the past decade. However, these headlines have just been focusing on one application of blockchain technology.
How Blockchain Is Being Used
A few years ago many people were talking about the revolution that was coming to investment banking, capital markets, the legal profession, global trade, medical records, and anything else that utilized or relied on data. Development on these private blockchain implementations has been running full steam as companies like IBM (IBM) and Microsoft (MSFT) have developed frameworks that are bringing solutions to market.
Examples of partnerships include IBM’s Food Trust platform that helps create a clear stream of information about food products starting with data capture at the farm and continuing through all points in the supply chain to retailers like Krogers (KR) or Albertsons (ACI).
These implementations are built on private blockchains, meaning that transactions or data input is restricted only to platform participants. Another aspect of private blockchains is that participants can control the level of transparency provided to other participants and users of the system. In the case of IBM’s Food Trust, users of the system might be consumers who scan QR or other codes to access information like harvest date, location, shipping data (including conditions), and in some cases fair-trade verification.
Readers of a certain age will remember there was once a day when one of the final steps in the settlement of an equity trade was for a clerk at a seller's broker to physically move stock certificates to a buyer's broker (which used to be a common starting point for one's career on Wall Street, as a "runner"). The electronification of this process began as early as the late 1960s and while the corporate structure of what has become the Depository Trust & Clearing Corporation (DTCC) has changed a few times over the years, the days of bonded couriers (the aforementioned “runners”) are long gone.
Trades have been settling electronically for decades now and the DTCC measures its annual activity in the quadrillions. Over the past decade the DTCC has become a member of Hyperledger, The Ethereum Alliance and other industry groups, and has been developing blockchain technology capable of consistently and securely providing trade clearing and settlement services for the past few years. They have had several tests over recent years with various market participants, and once they are able to implement a blockchain-enabled solution, the post-trade landscape of settlement and clearing will have been radically changed.
So far, we have been discussing blockchain technology in the context of data storage. In 2013, a programmer named Vitalek Buterin was convinced that using blockchain technology only for data storage was limiting the potential for the technology and published a whitepaper describing “Ethereum,” which essentially is a blockchain technology where the blocks aren’t simply repositories of information but actionable events - “Smart Contracts.”
Instead of recording the results of transactions, these blocks would both facilitate the transactions and provide the official record of them. An application of this technology (interestingly, without a distributed ledger, or database) includes the “Platts Trade Vision” platform launched by S&P Global Platts in November 2019 which captures and verifies commodity trade information that in turn feeds Platt’s commodity pricing products.
Why Hasn't It Become Mainstream Yet?
When it comes to removing friction and middlemen in commerce, the implications of smart contracts and blockchain technology are enormous. Today, the difficulties of integrating this technology have to do with the fact that the world is still very much a physical place.
For example, imagine using your phone to complete a car rental agreement, walk directly to that car, and use your phone as the car's key. With Apple’s (AAPL) forthcoming iOS 14 and its Car Key feature, this is on the cusp of becoming reality. What if doing a title search when buying a home was a simple as inputting the address into the front end of a blockchain filled with historical titles, providing a detailed history of every owner of record?
You will notice that the real-life examples of Blockchains and Smart Contracts seem to be limited. That's because they are limited to more experimental applications. Adoption of these new systems is often a radical step away from existing business practices; it's not just the adoption of a "new database" that companies need to embrace, but all the processes and systems that feed that data which need to be adapted as well. It will take some time and there will be pain but the positive outcomes affecting payments, supply chain management, regulatory frameworks, ESG reporting and other aspects of commerce will be worth it.
How to Invest
Investors interested in following this space can look to the following exchange traded funds (by order of assets under management):
- Amplify Transformational Data Sharing ETF (BLOK)
- Reality Shares Nasdaq NexGen Economy ETF (BLCN)
- First Trust Indxx Innovative Transaction and Process ETF (LEGR)
- Goldman Sachs Finance Reimagined ETF (GFIN)
- Innovation Shares Next Gen Protocol ETF (KOIN)
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Chris Versace
Christopher (Chris) Versace is the Chief Investment Officer and thematic strategist at Tematica Research. The proprietary thematic investing framework that he’s developed over the last decade leverages changing economic, demographic, psychographic and technology landscapes to identify pronounced, multi-year structural changes. This framework sits at the heart of Tematica’s investment themes and indices and builds on his more than 25 years analyzing industries, companies and their business models as well as financial statements. Versace is the co-author of “Cocktail Investing: Distilling Everyday Noise into Clear Investing Signals” and hosts the Thematic Signals podcast. He is also an Assistant Professor at NJCU School of Business, where he developed the NJCU New Jersey 50 Index.
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Lenore Elle Hawkins
Lenore Elle Hawkins has, for over a decade, served as a founding partner of Calit Advisors, a boutique advisory firm specializing in mergers and acquisitions, private capital raise, and corporate finance with offices in Italy, Ireland, and California. She has previously served as the Chief Macro Strategist for Tematica Research, which primarily develops indices for Exchange Traded Products, co-authored the book Cocktail Investing, and is a regular guest on a variety of national and international investing-oriented television programs. She holds a degree in Mathematics and Economics from Claremont McKenna College, an MBA in Finance from the Anderson School at UCLA and is a member of the Mont Pelerin Society.
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Mark Abssy
Mark Abssy is Head of Indexing at Tematica Research focused on index and Exchange Traded Product development. He has product development and management experience with Indexes, ETFs, ETNs, Mutual Funds and listed derivatives. In his 25 year career he has held product development and management positions at NYSE|ICE, ISE ETF Ventures, Morgan Stanley, Fidelity Investments and Loomis Sayles. He received a BSBA from Northeastern University with a focus in Finance and International Business.
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