Streetwise Professor

August 1, 2018

This Is My Shocked Face: Blockchain Hype Is Fading Fast

Filed under: Blockchain,Commodities,Cryptocurrency,Economics — cpirrong @ 7:02 pm

Imagine my great surprise at reading a Bloomberg piece titled: “Blockchain, Once Seen as a Corporate Cure-All, Suffers Slowdown.

That was sarcasm, by the way.  I’ve long and publicly expressed my skepticism that blockchain will have revolutionary effects, at least in the near to medium term.  In my public speaking on the topic, I’ve explored the implications of three basic observations.  First, that blockchain is basically a way of sharing/communicating information, which can in turn be put to various uses.  Second, there alternative ways of sharing/communicating information, with different costs and benefits.  And third, it is necessary to distinguish between sharing information within an organization and between organizations.

Much of the hype about blockchain relates to the potential benefits of more efficient sharing and validation of information.  But this does not address the issue of whether blockchain does this more efficiently than alternative means of sharing/communicating/validating.  As in all institutional/technology issues, a comparison of alternatives is necessary.  This comparison has been sadly lacking in public discussions of the potential for blockchain, beyond incantations about blockchain eliminating the need for trusted third parties which is (a) often untrue (in part because trusted parties may be required to enter information into a blockchain, and (b) is not necessarily a feature, because trusted third parties may be able to operate more efficiently than consensus based systems employed on a blockchain.

The most developed implementation of blockchain (Bitcoin) involves very large cost to solve a particular problem that (a) is unique to cryptocurrency, and (b) is not necessarily important in other contexts–namely, the double spend problem in crypto.  Maybe blockchain is the best way to solve that particular problem (which itself begs the question of whether cryptocurrency`is an efficient solution to any economic problem), but that doesn’t mean that it will be a more efficient way of solving the myriad types of opportunism, fraud, and deceit that plague other kinds of transactions.  Double spend is not the alpha and omega of transactional challenges.  Indeed, it might be one of the most trivial.

Thinking in Williamsonian transaction cost terms, where the transaction is the unit of analysis, transactions are highly diverse.  Different kinds of transactions are vulnerable to different kinds of information and opportunism problems, meaning that customized blockchain approaches are likely necessary.  One likely cause for the waning enthusiasm mentioned in the Bloomberg article is that people are coming to the recognition that customization is not easy, and it may not be worth the candle, compared to other ways of addressing the same issues.  Relatedly, customization makes it harder to exploit scale economies, and recognition of this is likely to be making initially enthusiastic commercial users less keen on the idea: that is, it may be possible to use blockchain in many settings, but it may not be cost-effective to do so.

The siloed vs. cooperative divide is also likely to be extremely important, and the Bloomberg article mentions that issue a couple of times.  The blockchain initiatives that do seem to have been implemented, at least to some degree, as with Maersk in container shipping or Cargill with turkeys, are intra-firm endeavors that do not require coordination and cooperation across firms, and can exploit the governance structure that a firm has in place.  Many of the other proposed uses–for instance, in trade finance, or in commodity trading, both of which require myriad parties in a single transaction to communicate information among one another–are inherently multilateral.

This creates all sorts of challenges.  How can commercial rivals cooperate?  How are the gains from cooperation divided?–this is a problem even when participants supply complementary services, such as a trading firm, banks providing trade finance, and the buyer and seller of a commodity.  As oil unitization has shown, battles over dividing the gains from cooperation can dissipate much of those gains.  Who gets to see what information?  Who makes the rules?  How?  How are they enforced? What is the governance structure?  How is free riding prevented?  Who pays?

Ironically, where the gains from cooperation are seemingly biggest–where there are large numbers of potential participants–is exactly where the problems of coordination, negotiation, and agreement are likely to be most daunting.

I’ve drawn the analogy between these cooperative blockchain endeavors and commodity exchanges, which (as I showed in a 1995 JLS paper) were formed primarily as ways to reduce transactions costs via cooperative rule making and enforcement.  The old paper shows that exchanges faced serious obstacles in achieving the gains from cooperation, and often failed to do so.  Don’t expect blockchain to be any different, especially given the greater complexity of the transactional problems that it is being proposed as a fix.

Thus, I am not surprised to read things like this:

“The expectation was we’d quickly find use cases,” Magnus Haglind, Nasdaq’s senior vice president and head of product management for market technology, said in an interview. “But introducing new technologies requires broad collaboration with industry participants, and it all takes time.”

or this:

Most blockchains also can’t yet handle a large volume of transactions — a must-have for major corporations. And they only shine in certain types of use cases, typically where companies collaborate on projects. But because different businesses have to share the same blockchain, it can be a challenge to agree on technology and how to adopt it.

One of my favorite illustrations of the hype outstripping the reality is the endeavor launched with much fanfare in the cotton market, where IBM and The Seam announced an endeavor to use the blockchain to revolutionize the cotton supply chain.   It’s been almost two years, and after the initial press releases, it’s devilish hard to find any mention of the project, let alone any indication that it will go into operation anytime soon.

Read the Bloomberg article and you’ll have a better understanding of R3’s announcement of an IPO–and that they might have missed their opportunity.

In 2017 and a little before, Blockchain was a brand new shiny hammer.  People have been looking everywhere for nails to pound with it, and spending a lot of money in the effort.  But they’re finding that many transactional problems aren’t nails, that there are other hammers that might do the job better, and there are other problems that require many parties to agree on just how the hammer is to be used and by whom.  Given this, it is not surprising that the euphoria is fading fast.  The main question that remains is in what shrunken domain will blockchain actually be employed, and when.  My guess is that the domain will be relatively small, and the time until employment will be pretty long.

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  1. I might make a bit of a counterpoint. We have passed through the hype phase and are into the development and implementation phase. Agree, have not seen much here. However, I think in many of the verticals that they are attacking, a lot of native expertise is needed to solve the problem-and a lot of education to the community. There can be reticence from established, entrenched, or older players.

    Maybe blockchain takes 10-15 years to show what it’s worth?

    I do recall people making fun of the dot com. Then came Google et al

    Comment by jeff — August 1, 2018 @ 7:32 pm

  2. Oh, and forgot to say that a lot of the people working on issues inside different verticals don’t have a lot of domain expertise. They are awesome coders etc, but might not necessarily know the finer points of banking or insurance to actually get it right.

    Comment by jeff — August 1, 2018 @ 7:33 pm

  3. @jeff–I largely agree with your points. I would say that the implementation is in a much narrower range than was touted in the hype phase.

    And the lack of domain experience is a big issue. This is part of the reason for the hype. They didn’t know what they didn’t know and just assumed that their awesome coding would overcome any issues. That’s largely because they didn’t understand the real issues, and (as I wrote in an earlier post) didn’t pose the Chesterton’s Fence question: why are things the way they are? They largely assumed that it was ossified thinking and technical ignorance, when in fact they were ignorant in important ways.

    Comment by cpirrong — August 1, 2018 @ 8:43 pm

  4. Excuse me if I am wrong.

    In economics, institutional structures are set up to minimise costs in the broadest sense (as per your article example on the establishment of exchanges). On that basis, the current transaction processing arrangements are those that–in total–minimise these costs. What blockchain (and I presume any rival tech-solutions) address is one specific issue within the process, as you rightly pointed out in your posts on this topic.

    I suppose my question and why I remain a bit baffled by the hype is: How does blockchain — in the round — create a more efficient system?

    Like you, I just don’t see it.

    As with many things, we find that technology affects one or two areas in a big way leaving the rest largely undisturbed. A few operators will probably greatly benefit but the overall system?

    But perhaps I’m missing something?

    Comment by Peter Moles — August 2, 2018 @ 2:20 am

  5. @Peter–you’re not wrong, so no excuse necessary 😉

    Comment by cpirrong — August 2, 2018 @ 4:13 pm

  6. Most of these corporate deployments (like blockchain cotton) remind me of the linear thinking common in the early dotcom days. Time magazine becomes Time the website, we just need some coders, eh? The revolutionary potential of the web didn’t appear until we got disruptive bloggers, and obstreperous commenters, challenging conventional wisdom in unexpected ways and at prodigious speed.

    I don’t care about some Wall Street whizz-bang consultants launching a blockchain cotton futures market. I want to see un-banked cotton farmers in Kenya get better prices for their product (and lower prices for their inputs) with cryptocurrency and smart contracts. That is the kind of revolution I want, and the sooner the over-hype dies down, the sooner the real revolutionaries can get to work doing what is important. And ByGodAlmighty there is a tremendous amount of work to do. Straight-up cryptocurrency user software is getting reasonably good, but smart contract user software is nowhere near being simplified and standardized enough to be usable to the diffuse groups that can benefit. Too many coders are focused on the Awesome New Idea and too few on things like making the handling of crypto keys secure, reliable, and easy to understand.

    And y’know, a revolution can come without anyone getting rich off it. Sure, Microsoft rode the PC revolution (at IBM’s expense), but the revolution in passenger jet technology left the airlines impoverished. Most of the benefits in that case flowed to the fare-paying public, and hooray for that.

    Comment by M. Rad. — August 3, 2018 @ 6:00 pm

  7. I think that a lot of the blockchain hype in the corporate world is a reaction to the rise of proprietary platforms. There is a lot of strategy stuff being put out that points out the lucrativeness of successful platforms and how they may be able to capture value from all the other players who participate. Large corporate customers are terrified of somehow getting locked in as a user to a dominant platform, with ensuing articles all over the place about how farsighted the platform purveyors were compared to the hidebound single-sided product sellers. (Note that this is mostly a concern for big firms–small firms don’t have large rent streams to appropriate yet, and they are more concerned with expediently achieving growth than thinking about the endgame should they pass the great competitive filter. Newish platforms such as Flexe [warehouse space sharing] and rivals are still a big phenomenon.)

    Blockchains (or any kind of distributed ledger system–there are other white papers out there, like one for hashgraphs) have been seen as a way to exploit the potential efficiencies of the Internet in B2B markets without empowering a platform owner. To the extent that it turns out that platforms do not inevitably become lucrative monopolies, I expect enthusiasm to die down. But I also think that the post-hype stage will make ti easier for the more economically and technically meritorious systems to come to the fore.

    Comment by srp — August 4, 2018 @ 7:03 pm

  8. One benefit of blockchain hype may be that it allows useful ideas about smart contracts that have languished to find an audience. Mark Miller (who I know thinks pretty hard about market architectures) has started Agorics to allow ordinary Java programmers to use stronger security methods in programming smart contracts, with the hyped application being attachment to blockchains.

    Comment by srp — August 4, 2018 @ 7:12 pm

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