Blockchain is much more than the crypto ‘Wild West’

A compelling investment story lies beyond Bitcoin in the blockchain, more specifically the companies built on it or that otherwise harness it.

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  1. Rob Morgan

Bitcoin and other cryptocurrencies have attracted huge interest among investors, I’m sure drawn to it by the meteoric price rises and social media frenzy. Worryingly, it seems lots of people are ploughing money into this latter-day gold rush without knowing what they are doing and with a blasé attitude to risk.

Just like the nineteenth century gold rush I fear it means it means riches for the few, early pioneers and not the many that followed. Gold mining in new frontiers such as California and Australia made fortunes for some, but most miners found it unprofitable. Those providing services surrounding migration and trade often prospered, though, and in the crypto ecosystem there are some interesting parallels.

I previously wrote about how crypto currencies were not so much an investment as a gamble, informed or otherwise, but also mentioned that there could be some big winners from harnessing decentralised money or other systems through blockchain technology. The coins and token themselves may not be the central investment story. They have no intrinsic value and they are not an asset in the same way as shares or real estate confer the value of a business, property or revenue stream – they are simply an idea of what could constitute money in a decentralised system. They could rise in value a lot given sufficient mainstream adoption, but they could also end up being fool’s gold rather than the real deal.

Perhaps the more compelling investment story behind Bitcoin is in the blockchain itself, and more specifically the companies that are built on it or otherwise harness it. And the good news is that investors could get exposure to this area through ordinary fund or share dealing on a regulated exchange – there is no need to up sticks to the crypto Wild West.

What is a blockchain?

Blockchain technology is a decentralised ledger that protects data from fraud and updates all parties involved in the network. Computers connected to the network agree the ledger’s position at regular intervals and agree to any changes – in the case of crypto when any transactions take place. Since anyone can check a proposed change against the ledger, the system is ‘decentralised’ with no single party controlling the blockchain.

The technology offers some very useful applications. With cryptocurrency it creates a bearer ‘asset’ that can be securely moved anywhere in the world, whenever required. More broadly, blockchain enables any type of encrypted data – be it personal or company information, medical records or financial transactions – to be shared between members of a network. Those members could constitute various parts of an organisation, or they could be across spread across whole industries to enable complex transactions or information dissemination to take place with agreed protocols. The potential to cut out paperwork and unnecessary layers of administration and intermediaries is huge, driving efficiency and opportunity.

The blockchain opportunity

The current financial system, for instance, is inefficient with straightforward transactions often requiring lots of different parties. Error resolution can be a painstaking process involving manual intervention. Across many other industries invoicing and reconciliation can take weeks. Blockchain provides the technology to reduce these frictions, minimise costs and automate manual processes in complex systems. The downside is that it requires significant upfront cost to innovate and completely new skill sets for those adopting them.

Rewiring with a blockchain can occur in two main ways. It can either sit on top of existing systems to speed them up, or the more revolutionary and potentially disruptive route is to completely redesign a system from the ground up. This might provide a better outcome but is potentially more difficult to implement due to the inertia of incumbent companies that own customer relationships and the regulatory ‘moats’ around certain industries, notably financial infrastructure.

Blockchain can house so-called ‘smart contracts’, which permit transactions and agreements to be carried out digitally between various parties. It’s a kind of alternative to a legal contract because it’s immutable once agreed and created but with the bonus that it executes automatically and without the need for a central authority, legal system, or external enforcement. All participants can be certain of the outcome and that it will be carried out without delay. The possible applications are vast, notably in financial transactions, insurance or legal workflow – anywhere an action is required when conditions are met.

Smart contracts are what actions and potentially monetises a blockchain, reducing the need for middlemen and providing faster, cheaper transactions and processes. A popular analogy is a vending machine cutting out the need for a shopkeeper and complicated, expensive infrastructure. Adding money to the machine and selecting an item simply results in the snack being dispensed.

The Ethereum blockchain, whose currency is second only to Bitcoin in terms of overall value, was designed to support smart contracts, but there are various others that do too. One example of a popular smart contract is a nonfungible tokens (NFT), which allows artists to sell direct to a buyer digitally without the need for an art dealer or agent. So far, this has mainly been used for ‘digital art’ transactions, but a physical piece of artwork or a music royalty could also have an NFT assigned to it.

A new frontier

Abstract as it may seem, smart contracts distributed across a blockchain could revolutionise the way business is done. Users would experience smart contracts through decentralised apps or ‘dapps’ that essentially turn the technology and agreed protocols into useful functions. Just as an ‘app’ on a smart phone performs certain functions (via a centralised process and server), a dapp runs on a decentralised peer-to-peer network and harnesses the benefits of blockchain such as automation and efficiency for the everyday user.

While this may seem very exciting, the uptake of blockchain technology is in its infancy. Smart contracts can’t currently interact much with the wide range of systems required to establish them more broadly. For the most part they reside in their own world, cut off from the traditional, closed systems we are all familiar with. Mass adoption may not come quickly but harnessing the right companies that either build out or embrace this technology successfully could offer some interesting opportunities.

It’s a trend to keep an eye on and it could be far more fruitful than backing individual coins and tokens, which represent the ‘currencies’ of these new networks and a high risk ‘option’ on their success or otherwise. It’s also a disruptive trend that could see incumbent intermediaries that don’t add value or own customer relationships cut out of the systems they operate in.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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