Blockchain – A Technology Hailed for Championing Decentralization Might Paradoxically Increase the Power of Platforms
As incumbents in finance and tech are fretting about decentralized applications, Google and Amazon have already moved beyond the myths and are aggregating blockchain services.
Every day the digital paradigm is strengthening its grip on businesses, mostly through incremental improvements such as making a website more user-friendly or offering an online-banking app. Only rarely do we come across technological breakthroughs that have the potential to simultaneously disrupt back office processes, arenas of competition, and business models. The inventions of the internet and cloud computing have been such radical innovation. So is the distributed ledger technology blockchain. Yet while its impact on process improvements has been documented meticulously, business model transformation has not. The only forecast, repeated like a never-ending mantra, is that trust institutions such as banks and platforms such as Facebook are forecast to be out of business soon. This is wishful thinking of the hard-core crypto-scene. In fact, the opposite can be the case. To show why, we first must look at the succession of economic paradigms.
Each techno-economic era carries with it a preferred business model. Broadly speaking each company uses one of four major ways to earn money. Each of them is enabled by different technologies and assets and each of them results in different profitability levels.
First, there are asset builders that create and deliver value via utilizing physical assets. Steel manufacturers need large-scale plants with expensive machinery. Second, there are service providers that base their value delivery on their human capital. A cleaning company might not require machinery, but squads of personnel. Third, technology creators use intellectual capital to sell their ideas and intellectual property such as software. Licensing costs you pay for your computer’s Windows-system go to highly-trained software-developers who build the system and keep it running.
And finally, network orchestrators employ their network capital to deliver value. They give customers access to other participants of a network. Newspapers sell their readers to advertisers, but orchestrator advantages manifest best by utilizing both, network assets and technology as in the case of search engines and social media platforms. Such platforms represent the typical business model of the digital age.
Empirical results indicate that network orchestrators dramatically outperform the rest in terms of profitability. Still, there are hardly any companies switching their business model. For some enterprises the model does not fit, for others the investment into the respective assets is too high. Yet often companies simply lack the expertise to apply transformational technologies. The leap from service provider to platform is harder than the leap from asset builder to service provider (e.g. leasing machines instead of selling them), not least because it hinges on a particular technological breakthrough and the quick capturing of a significant market share. That is why network orchestrators still only account for 2% of all publicly traded companies. For banks, who are prototypical service providers, blockchain can mean more than cheaper databases and transactions. It can be the gateway to becoming a platform of trust.
Institutions of trust are still part of the equation
So how exactly does a platformization-model fit to the precept of decentralization, for many the core of the entire blockchain idea? After all, experts proclaim that blockchain will disrupt, rather than enforce platforms. They talk about the “Uberization of Uber” via so-called decentralized apps (dApps). Blockchain presumably eliminates the need for a trusted entity, so why bother with trust institutions that manage the network? This is a very prominent misconception. While the blockchain indeed enables a transaction mechanism that is tamper-proof and needs no middleman, data and ledgers still need to be kept safe before and after transactions. The Mt. Gox scandal, in which hundreds of thousands of bitcoins were lost, is a case in point. At the end of the day somebody still must safeguard things such as private keys to access the accounts on the ledger. A banking license will still be appreciated by customers as it gives them the necessary peace of mind.
But not even the verification mechanism itself is certain to cut out trusted institutions. In the decentralized model propagated by the first blockchain applications this was true. Yet today we can centralize decision power in the consensus mechanism with so-called permissioned or centralized blockchains. In this setup not all nodes are equal. Their number is limited, or they are assigned a different weight when deciding on transactions. This model looks likely to prevail in many use cases because it eliminates disadvantages of decentralized applications. Its verification mechanism does not burn nearly as many gigawatts, nor does it have the same scaling and latency problems. Ergo, while the ledgers are distributed, they must not necessarily be decentralized and thus do not automatically lead to the erosion of centralized institutions’ power.
Now to the platform potential blockchain can unlock for banks and other centralized giants: The technology’s promise of immaculate security triggers an explosion of services in payments, digital identity verification, and medical information storage, to name but a few. In all those cases the tamper-proof mechanism needs to be managed by a trusted party. Though these services currently cannot be linked to each other, in future a major benefit for the customer is if they are offered by one trusted, blockchain-fueled source. Predestined for this custodian role are banks. Their core competencies include massive customer portfolios and instantly recognized brands. They have spent centuries pounding the message that you can entrust them with your wealth. This puts them at an ideal spot to become the go-to address for all things related to digital trust.
A platform approach set to succeed
Marco Iansiti and Feng Zhu, both from Harvard Business School, have identified 5 core principles why some platforms succeed while others fail. Observed in this light, a blockchain-powered trust platform is set to thrive.
First, it would not be prone to network clustering. Uber, for example, has the problem of local fragmentation making it hard to ensure supplies on both sides of the platform – drivers and passengers. Not so a digital trust platform that is mostly unhinged from local, physical supply and demand.
The risk of disintermediation is low too as customers would use the banking hub precisely because it adds this layer of security. Thus, they will not seek to bypass it.
The strength of network effects, meaning that more products attract more customers, also plays into the hands of such a model.
Some platforms are vulnerable to multi-homing, but with good pricing and product combinations banks could mitigate the threat of sharing the customer with competitors as well.
The fifth dimension, network bridging, can also help, namely by connecting to other networks that offer complementary products.
For banks to reap the rewards described in the beginning of the chapter, it cannot be just any type of platform. Linking customers to providers of financial or trusted blockchain services is not enough. An aggregator model is needed. Banks have to subsume third-party products under their umbrella, preferably white-labeled, in order to leverage their core asset as a broker of trust. If HSBC or J.P. Morgan Chase take the liability for the protection of my medical data, then this is an added benefit for me as a customer.
Data giants are already aggregating blockchain services
To some this might sound like theoretical ruminations conducted in the ivory tower of management theory, but a look at the actions of today’s tech giants shows they are already working on such a model.
As of today, Amazon Web Services (AWS) runs the world’s largest infrastructure for building end-to-end blockchains and has released two major blockchain products. Google, for years one of the most active investors in blockchain companies, now puts its major hope in its Blockchain-as-a-Services platform (BaaS). Those platforms built by Google and Amazon bring together app developers and companies, but there is no reason why this model should not be replicated in the B2C realm.
In any case, banks must learn from it. Many financial institutions have been slapping fancy apps on derelict legacy systems and labelled it “digitalization,” but being a truly digital firm also encompasses adapting back-ends and business models.