August 2016

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The Search for New S-Curves

We have written extensively over the years about searching for new S-Curves: technologies and innovations that enjoy rapid, and in many cases game changing, growth. Some examples are biotechnology, internet, wireless technology, nanotechnology, cloud computing, smart phones, and in earlier eras, planes, trains, and automobiles. All of these innovations disrupted contemporary business models and ushered in completely new industries. Owning businesses that have either invented or benefitted from these rapidly growing S-Curves has proven extremely profitable. So we turn to a new innovation that is quietly beginning to transform how we securely transfer money, data, and information: blockchain technology.

What is Blockchain?

Blockchain is defined as “a massive, fraud-resistant distributed digital ledger of transactions that could be the new infrastructure of the future. The open ledger uses consensus algorithms to transparently record and verify any transactions without a third party.” It replaces the middleman with mathematics. Because the blockchain infrastructure is decentralized, it results in less friction and time wasted than traditional, centralized processes.

Blockchain infrastructure has no central authority (much like the internet or Wikipedia) and relies upon a combination of encryption technologies, the inability to change inputs, and the integrity of its users. This allows each participant on the network to utilize the ledger in a secure way. Blockchain fans, including large banks, governments, and Wall Street firms believe that the technology can change the future of how transactions are handled. In addition to financial institutions, industries as varied as media, real estate, healthcare, and government central banks are looking into its applications.

Where Did It Come From?

Bitcoin, the world’s largest cryptocurrency, was the first application built utilizing blockchain technology. Marley Gray, director of technology strategy for financial services at Microsoft wrote, “In 2008, a person or group of people known as Satoshi Nakamoto published a paper describing bitcoin and how it could be used to digitally send payments between any two willing entities without the need for a third-party financial institution. Each transaction was recorded on the blockchain ledger, the newest block tied to the ones before it using a digital signature. To ensure trust in the ledger, participants on the network ran complicated algorithms to verify those digital signatures and add transactions to the blockchain.”

Wall Street Journal journalist Steve Norton recently wrote, “The term blockchain today usually describes a version of this distributed ledger structure and distributed consensus process. There are different blockchain configurations that use different consensus mechanisms, depending on the type and size of the network and the use case of a particular company. The bitcoin blockchain, for example, is public and ‘permissionless,’ meaning anyone can participate and contribute to the ledger. Many firms also are exploring private or ‘permissioned’ blockchains whose network is made up only of known participants.”

Recent Headlines — Gaining Traction

A recent report from Moody’s Investor Services provided a comprehensive list of every blockchain project going on in the world. The survey identifies more than 120 ongoing projects including startups, internal projects, and industry collaborations. Here are several recent headlines related to this technology:

IBM Moves Blockchain to the Supply Chain Realm
Toyota Unit Joins R3 Blockchain Group
Downfall of DAO Digital Currency Fund Shows Blockchain Reputational Risk
Microsoft to Launch Blockchain Middleware
Facing the Financial Industry’s Cyber Challenge with Lessons from IT History

How It Works

Large organizations and governments face huge and evolving challenges in data management and security. Blockchain is emerging as a way to verify transactions on a network instantaneously and securely. For example, dozens of financial institutions and a growing number of companies in varied industries are developing blockchain as a secure and transparent way to digitally track the ownership of assets. This speeds up transactions while cutting costs. More importantly, it significantly lowers the risk of fraud. Other industries see the opportunity to use blockchain to track the movement of assets throughout their supply chains or electronically initiate and enforce contracts. Quoting Steve Norton again, “Once a block of data is recorded on the blockchain ledger, it’s extremely difficult to change or remove. When someone wants to add to it, participants in the network — all of which have copies of the existing blockchain — run algorithms to evaluate and verify the proposed transaction. If a majority of nodes agree that the transaction looks valid — that is, identifying information matches the blockchain’s history — then the new transaction will be approved and a new block added to the chain.”

From a security perspective, each transaction receives its own digital fingerprint. As each transaction occurs, sometimes dozens or thousands per second, these unique fingerprints make up a collective signature. This signature is then confirmed by both the sender and the recipient for confirmation. It is then stored in the blockchain for network participants to see. This data is now memorialized and stored on the network. Signatures are continually validated by the client and if subsequent signatures appear and are different, then subsequent transactions are not validated. All of this adds up to an extremely secure method of transacting data and information.
Eliminating the Middleman

A good example of this is in financial services, where trades are currently verified by a central clearinghouse that maintains its own central ledger. Blockchain technology would eliminate that clearinghouse by giving each bank in the network its own copy of the ledger. A common network protocol and consensus mechanism would allow the participants to communicate with one another, and would confirm its own transactions. Confirmation would be handled automatically in seconds or minutes, not days. This would significantly cut costs and boost efficiency.

Delap is always endeavoring to invest in companies which are on the cutting edge of technology and innovation. We utilize a combination of fundamental analysis and a top down view with strategic theme overlays. Looking over the horizon into new and emerging S-Curves is what we do. Over the next several years, we will be evaluating the implications of this exciting new blockchain technology as beneficiaries emerge.