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Blockchain is a form of distributed ledger technology (DLT) that uses sophisticated cryptography to store data across computer networks. It has been billed as a solution to almost every challenge known to humanity. But it remains mysterious to most people—and largely untested. Is there potential beyond the hype?

True believers think blockchain could eliminate the need for intermediaries in a wide array of transactions and will transform virtually every corner of the global economy—not just the financial system, but also energy markets and supply chains.

In 2017, IFC worked with key influencers to examine the potential and perils of blockchain. Conclusions suggest that blockchain could be valuable to developing economies by promoting greater financial inclusion and improving productivity.

But, as with all new technologies, a healthy dose of realism is necessary—and not just because of the collapse in cryptocurrency prices. The international financial system is built on trust between transacting parties, and the potential anonymity of blockchain hinders that trust. For all their advertised advantages, blockchain databases remain much less efficient than traditional databases.

That may be one reason blockchain has entered the “trough of disillusionment” on technology consulting firm Gartner’s “hype cycle,” which provides a view of how new technologies are expected to mature over time.

That’s not to say the technology will never be useful. Gartner says the trough of disillusionment can be followed by a productive period in five to 10 years.

Experts agree that blockchain is in its infancy. It will need to overcome serious technical and regulatory challenges if it is to achieve widespread adoption.

To learn more about these challenges and opportunities, IFC PERSPECTIVES asked industry leaders to share their views.
Matthew Saal, Head of Digital Finance, Financial Institutions Group, IFC
Andi Dervishi, Global Head, FinTech Investment Group, IFC

Blockchain and distributed ledger technology (DLT) drove the rise of cryptocurrencies, but it’s critical to look beyond the hype when assessing the potential benefits for developing economies. This is particularly important because we see that even in developed settings the technology is still maturing.

We don’t see developing economies as a different class regarding the technology. The adoption cycle may be different—either slower or faster, with the possibility of development leapfrogging traditional infrastructure, as was the case with mobile phones in Africa—but the applications are largely the same.

When we look at potential investments in companies that are pursuing DLT initiatives, we’re not assessing the opportunity with the goal of proving whether blockchain or DLT works or not. We invest in companies that are solving a problem and growing their customer base with whatever technologies are appropriate to their needs.

For example, in July 2018 IFC committed a $3 million investment in Twiga Foods, a Kenyan delivery service that runs a cashless platform through which vendors order and pay for fresh food and vegetables. By eliminating layers of middlemen, Twiga creates more efficient supply chains, benefiting farmers and vendors. The Twiga system, which has brokered 200 million bananas, uses conventional technology and mobile connectivity. IFC has also supported IrisGuard, which has developed a biometric ID technology that has been deployed in ATMs and linked to aid distribution programs for Syrian refugees in Jordan. Twiga is now piloting a blockchain-based financing system, and IrisGuard has implemented a blockchain-based back-end payments system that may deliver incremental cost reduction for one of the benefits programs that uses its biometric ID.

“Without the critical mass of a sovereign or a big corporate backer, any transition from a centralized system will be difficult. Business models will need to change.”

Caution is warranted, however, with respect to the commonly held belief that DLT can “replace trust,” especially in trade and supply chain applications. Applications of DLT that eliminate intermediaries have so far involved assets that exist solely within the system, such as cryptocurrency. Anything meant to represent assets that exist in the broader world—such as a banana in a supply chain—requires an intermediary to create the link between the crypto-asset and the real asset. This is necessary to verify that the banana exists and is in the condition it’s supposed to be in. Because of this, beyond cryptocurrencies, DLT does not actually dispense with trusted third parties.

In 2018, IFC made a $3 million investment commitment to Twiga Foods, which runs a cashless platform through which vendors order and pay for fresh food. Twiga is now piloting a blockchain-based financing system.

Given the higher cost and slower operation of systems, the net benefit of choosing DLT as an operational database for supply chains may be limited. Most proofs of concept to date have focused on the question “Can this be done using a blockchain?” rather than “Is blockchain the most efficient and effective way to do this?”

Although there may be applications where redundancy, transparency, or other features justify the current cost trade-off in favor of DLT, there’s a risk that the hype surrounding blockchain could be costly—in terms of time and money. Some blockchain applications may succeed, but that may be the result of the amount of capital being thrown at this technology right now, rather than because blockchain technology is a necessary part of the solution. As The Economist noted recently, “firms that deploy blockchains often end up throwing out many of the features that make them distinctive.”

Where blockchains do turn out to have a real advantage, implementation will be a steep curve. Without the critical mass of a sovereign or a big corporate backer, any transition from a centralized system will be difficult because a distributed ledger by its very nature deflates the hierarchies within it. Business models will need to change.

Large companies like Oracle, IBM, and Microsoft have some power to drive change in technology. Some dominant players in a supply chain may be able to dictate how others interact with them, but why they would use that power to socialize rather than concentrate control of the database is not clear. IFC will continue to monitor developments.

The intense experimentation and focused attention on the nature of ledgers, transactions, and counterparty connectivity could improve understanding of underlying processes and eventually result in useful applications. For most companies, though, it will pay to be a fast follower rather than to expend resources on speculative projects today.

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Djuri Baars and Chris Huls, Co-leads of Blockchain, Rabobank

Blockchain is immature but its potential is enormous, including in emerging markets. It’s like the Internet in the early 1990s—it’s clearly a game-changer, but it will take some time to really understand its practical use.

In our experience, blockchain and DLT more generally are most beneficial in domains where many stakeholders are involved, like trade finance and real estate. Even today, there is still a lot of paperwork involved in these processes, raising the risk of error and fraud. With the use of smart-contract functionality, which in some cases can function as a digital equivalent of legally binding contracts, DLT can increase trust in transactions between parties with conflicting interests.

In developing economies, where many people do not have a bank account, blockchain can provide access to finance for the increasing number of people who own a smartphone. Because cryptocurrency—one of the best-known applications of blockchain—lowers the need for some trusted third parties, the previously unbanked are now able to operate with low transaction costs and to make micropayments.

Using blockchain to facilitate micropayments also enables the development of sustainable pay-per-use platforms. This makes durable and long-lasting devices like kitchen appliances and farming equipment accessible for everyone, without a large investment upfront. Users pay for the equipment only when they use it, and therefore don’t need to worry about an initial outlay, guarantees, availability, or depreciation. Rabobank is already working on pay-peruse platforms to accelerate living in a circular and sharing economy.

“Blockchain can function as a single point of truth…but only if the solution is adopted by the majority of the stakeholders in the supply chain.”

It is important to highlight that DLT is a means to an end that presents opportunities for customers in the agriculture and food supply chains. In our Blockchain Acceleration Lab, we are investigating several solutions to the challenges customers face, including food provenance and safety. For example, a distributed ledger like blockchain can function as a single point of truth for food and agriculture-related transactions, but only if the solution is adopted by the majority of stakeholders. This helps organizations like ours better analyze the risk of pre-financing or investing in assets.

Rabobank is one of nine founding banks of the consortium, a blockchain-based platform (built on Hyperledger Fabric) to provide more trust for businesses when trading internationally. It’s about bringing customers of each member bank together to make the shared platform more useful—and more successful. If banks in Europe can prove the concept, the potential to deploy similar models in emerging markets could be enormous.

All sectors, institutions, and governments need to explore blockchain and DLT sufficiently to understand its significance, and it’s important to look beyond the hype. Collaborations like the Dutch Blockchain Coalition, where public and private organizations work together on fundamental challenges like identity and standardization, are great vehicles to increase understanding and bring the technology to the next maturity level.

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Marina Niforos, Founder, LogosAdvisors

Perhaps the most promising application that has received the least attention amid the cryptocurrency exuberance is the potential for DLT to transform global supply chains. The cost of operating supply chains has risen enormously as a result of their increased complexity and digitization. Blockchain may be the solution to many of the logistical, cost, and transparency issues that plague their growth.

Two attributes of blockchain may help boost trade facilitation and compliance with specific goals regarding sustainability and inclusion. These are the reduction of agency costs and the availability of auditable traceability. Two supply chains where specific experimentation with blockchain is taking place are food and agriculture, and pharmaceutical safety.

In food and agriculture, a blockchain-enabled workflow automation (via smart contracts and integration with key machinery and data collection points) and auto-reconciliation for inventory can reduce costs for both consumers and producers. This is significant, given that 80 percent of the cost of delivered goods in such traditional supply chains is administrative and procedural. Producers, who bear the disproportionate burden of retaining capital, also minimize their credit, liquidity, and operational risk by enforcing greater conformity. The distributed ledger model could additionally improve access for regulators and authorities with respect to collecting taxes and customs duties.

As to pharmaceutical safety, DLT, in combination with the Internet of Things, also provides a solution to track drugs. This is a critical public health issue in developing countries, where an estimated 50 percent of drugs that are consumed are counterfeit. Blockchain can provide a record of all transactions, including location, data, quality, and price, visible to all involved entities in real time to minimize record‑tampering.

“Blockchain may help to boost trade facilitation as well as compliance with specific goals regarding sustainability and inclusion.”

While these examples represent quick wins—DLT raises the efficiency of existing value chains—the technology is still evolving. As the technology matures, it continues to face hurdles of different kinds: technical, regulatory, and institutional. Limited access to capital may limit the development of the underpinning innovation ecosystem on which DLT depends. A narrow human-capital base—especially in the area of digital skills—may further limit the adoption. Agile regulatory frameworks are also needed to accompany the fast pace of change.

Regulatory sandboxes provide a useful approach to allow start-ups and regulators to learn together in practice and in a controlled safe space, so that they may make better-informed decisions about the boundaries of their respective responsibilities. The main drawback of regulatory sandboxes, however, is that they are limited to a single jurisdiction and do not accommodate the global reach inherent in the technology. One solution is the creation of a multijurisdictional sandbox composed of a college of regulators, or a global sandbox administered under the mandate of a multilateral institution such as the World Bank Group or the International Monetary Fund.

Meanwhile, regulators should provide some guidance to attract private-sector investors, ensure consumer protection and citizens’ rights, and provide safeguards against anti-competitive practices. The private sector should undertake initiatives to ensure industrywide interoperability and compliance with existing legislation and overall public-sector objectives such as the collection of taxes and the prosecution of illicit activities.

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Matthew Kerner, General Manager, Microsoft Azure

One of the first steps in any blockchain project is to take the business process and determine what an optimized version of that process would look like. An example is Insurwave, a maritime insurance solution that has been developed by the shipping company Maersk and partners including EY, Willis Towers Watson, and XL Catlin using Microsoft Azure infrastructure. It uses blockchain technology to dynamically adjust insurance policies for ships as they travel around the world.

We recently partnered with the World Bank Group and the Commonwealth Bank of Australia to launch the world’s first blockchain bond. Dubbed “Bondi” (short for Blockchain Operated New Debt Instrument), it uses a distributed ledger to automate bond transactions among sellers, buyers, and banks. It aims to reduce the time it takes to settle securities from days to a few seconds, while providing full transparency and cutting fees. If the technology can reduce the cost and effort of these transactions, then it frees up resources to focus on the World Bank Group’s goal of economic development.

Elsewhere, we’re excited to be working on a project called ID 2020, a private-public partnership with Accenture and the United Nations to bring digital identities to at-risk populations around the world. By creating a digital record of their citizenship and the place and time of their birth using blockchain, it enables people to access credit, to find employment, and to seek asylum. These digital identities can be bootstrapped to biometrics and don’t require a strong central authority to manage them, which means they really do belong to the individuals. And it’s open source, allowing organizations like the UN to more easily work with different vendors in each country.

“Organizations that seek to serve emerging markets need to spend some time watching and listening.”

Because emerging markets can suffer a lack of clarity with regard to regulations, people tend to assume more risk in using technology to solve problems. For example, information about who owns a cryptocurrency is encoded in the blockchain itself—it’s a purely digital asset. But in many cases, blockchain serves to represent a physical asset, and it’s possible to end up in a situation where the digital record differs from the physical reality. These divergences are more common in emerging markets, where systems cannot always accommodate the messy reality of the environments in which businesses operate.

Some economies may need to develop a little more before all the benefits of blockchain can be realized. For example, if people don’t have access to smartphones, their interaction with digital applications can be limited. But making technological compromises can create a solution that is more serviceable to the customer, such as designing a user interface using voice calls or SMS. To have real impact, blockchain solutions must integrate seamlessly with the systems these populations are already working with. Gaining that insight—and knowing exactly what the needs are—is very hard to do from a distance.

Organizations that seek to serve emerging markets need to spend some time watching and listening. In Nigeria, we have a team on the ground to identify potential customers and partners; we’ve found that the local tech scene in Lagos is tremendously strong. In China, we rely on local expertise to develop solutions that are adapted to the environments in which they will be deployed. Ultimately, that might mean doing more or different work in order to accommodate local constraints, but that’s what allows us to take better advantage of the opportunities.

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Andrew Kinai, Software Engineer, IBM Research—Africa

We’d much rather have a small slice of a big cake than a larger piece of something much smaller. And we think blockchain could be a very big cake. That’s why, after exploring DLT for several years, we donated our blockchain code to the Linux Foundation. We saw little value in building a proprietary blockchain platform and felt that if blockchain was going to take off then it needed to be an open standard.

The code we donated has now morphed into an open-source platform called Hyperledger Fabric, and IBM is just one of 245 organizations actively contributing to its development. Anyone can now download it. We want people to be able to experiment with blockchain. When they have something that’s really working, IBM can help them scale it. Whenever we develop solutions using blockchain, we make the application program interfaces (APIs)—that’s the way of connecting your blockchain to other people’s systems—open as well.

We’re currently working with companies of all sizes in many sectors across developed and developing countries. It’s important to establish the right partnerships so that solutions have longevity.

The IBM Food Trust, developed in collaboration with Walmart, aims to digitize supply chains. Allowing supply-chain issues to be traced in just minutes rather than days will dramatically reduce anxiety among consumers, minimize reputational impact, and cut stock-removal costs. Right now, the project is progressing in developed markets where the major costs are being covered by the largest players. But once proven, it has the potential to deliver meaningful benefits in emerging markets, too.

“Blockchain is a team sport. We are looking for opportunities to form consortia, where the trust that blockchain brings can spawn new business models and new partnerships.”

A more direct emerging markets example is Twiga Foods, a business-to-business logistics platform that connects small-scale farmers to shopkeepers in East Africa. In 2017, Twiga Foods partnered with IBM to build a blockchain-enabled lending platform to provide microloans to small retailers, enabling them to purchase food from Twiga’s suppliers.

Twiga Foods has partnered with IBM to build a blockchain-enabled lending platform to provide micro-loans—typically between $10 and $30—to small food retailers, enabling them to purchase food from Twiga’s suppliers.

Our goal is to create an ecosystem whereby individuals can deal with multiple suppliers and record all transactions on the blockchain. It will serve as a single point of truth and gives each individual a financial identity that can be accessed by suppliers and financiers, meaning they can get credit even without a bank account. The mobile-phone-based system uses SMS text messages, rather than requiring a smartphone, while repayments are made using M-Pesa, Africa’s leading mobile-money service.

Earlier this year, a pilot program at one of Twiga’s depots in Nairobi saw loans offered to more than 400 local retailers. During the eight‑week pilot we witnessed a 17 percent increase in order size and a 6 percent increase in profits for each retailer. Of course, this also has benefits for those up the supply chain. The most important lesson we’ve learned is to put the user first and make it easy f or them: by understanding how users work and what their day looks like, you can build a solution that fits how they operate.

IBM is focused on enterprise-ready blockchain, which is private and permissioned, so participants are known and the relationships among parties are defined by smart contracts at the heart of the network. There is no anonymity to hide behind: the immutability and transparency reduces the opportunity for fraud and corruption. However, issues related to cryptocurrencies may discredit the underlying technology that is shared with enterprise blockchain. We must be diligent.

Blockchain is a team sport. We are looking for opportunities to form consortia, where the trust that blockchain brings can spawn new business models and new partnerships.

Join the conversation: #IFCPerspectives

Published in October 2018