Blockchain is poised to oust middlemen across industries — here’s how it works
When an economy craters, its currency often goes with it. That’s been nowhere more true than in Venezuela. The bolivar has lost almost all its value against the dollar since April 2013. Because Venezuelan law forbids most people from exchanging bolivars for dollars, thousands of Venezuelans are trading in Bitcoin, the world’s most popular digital cryptocurrency. In February, Bitcoin trading in the country hit an all-time high, by one account, 157 times higher than the country’s largest stock exchange.
Bitcoin’s value in the real world derives in part from the fact that it runs on a blockchain, a distributed and transparent online accounting register, according to its proponents. One area startup — Woodbridge-based company Splash Factory — is helping Venezuelans make the switch to Bitcoin. The company designed an app called Monarch Wallet that lets businesses accept cryptocurrency payments and convert those to dollars and vice versa. It works the same way on the consumer side — buyers can pay in cryptocurrency and the app pays the vendor in dollars. Invented in the teeth of the 2008 financial crisis, “Crypto puts the power back in the hands of the people,” says Splash Factory founder Robert Beadles.
But Splash Factory and developers like it have a broader aim too: building blockchain applications that let people and businesses conduct transactions without intermediaries — brokers, agents, notaries, even web platforms. They imagine a real estate sale without agents, a sale of stock without brokers, or a peer-to-peer loan without a company website to transact on.
Imagine a real estate sale without agents, a sale of stock without brokers, or a peer-to-peer loan without a company website to transact on.
These evangelists say that blockchain technology makes transactions, especially complex ones, more secure, cheaper and faster than is possible with the current system. But the vast majority of blockchain startups fail, and critics say its enthusiasts are selling solutions that won’t deliver. If those concerns come true, businesses that buy their products and services could be headed toward big cash outlays with little to show at the end.
The “block” in blockchain refers to a digital block of information — say a seller, buyer and price. That block gets stored on computers around the country or world, and a block of data is valid only if the encoding is the same across all storage points. Imagine that, instead of computers accessing shared files from a server, those files are on a network of computers and revised synchronously. Each block is chained to the next with complex code, making it impossible to alter one without breaking its link to the next one.
Think of it as an old-time accountant’s ledger: If the blocks are the pages, as Paul Colleti of the BBC puts it, then the chain is the binding. A 2016 Goldman Sachs report defines it as a database of transactions or other records, with copies of the database replicated across many computers. Individuals and companies have created many different blockchains, some public, some private, others a mix.
Central to the technology’s power are the “smart contracts” that can run on it: mini-computer programs that execute transactions. A smart contract on a public blockchain lets a seller interact directly with a buyer with no intermediary: A buyer pays money, the payment is recorded on a blockchain, and the smart contract conveys the good or service to the buyer. To envision a smart contract, enthusiasts often encourage thinking of it like a vending machine — an automatic way for buyers and sellers to interact directly.
The idea? Automate the intermediaries into oblivion, or at least restrict their role. In the 2016 book “Blockchain Revolution,” which some consider the bible of the blockchain world, the authors assert that in our financial system, intermediaries “make the system work, but also slow it down, add cost, and generate outsized benefits for themselves.” Blockchain will move them out of the way because of its advantages in cost and speed.
If the proponents are right, blockchain represents the next phase in the internet’s evolution. One prediction about its coming impact is eye-popping: A forecast in July 2018 by IT market intelligence firm International Data Corporation estimated that worldwide spending on blockchain technology will grow from $1.5 billion to $11.7 billion by 2022.
California’s leaders decided last year that they can’t ignore that possible impact: A major factor driving where blockchain companies headquarter is well-defined regulations, say the technology’s advocates. So two related bills became law in 2018. AB 2658 defines blockchain and establishes a working group to research its potential uses, risks and benefits. SB 838 gets more specific, allowing California corporations to issue and transfer corporate share certificates via a blockchain instead of the more time-consuming and less secure traditional method of issuing actual share certificates. California was one of 18 states to pass blockchain legislation last year, and the number of states enacting blockchain-related laws has increased every year since Vermont passed the first one in 2015.
California universities are in on the action too, with three of the top 10 universities for blockchain classes in the world located here: Stanford, UC Berkeley and UCLA. Locally, UC Davis has a student-run blockchain organization supported by a team of professors and a blockchain club at the Graduate School of Management.
Not everyone believes the visions of blockchain evangelists. Jimmy Song, startup veteran, developer, programmer and partner at San Francisco-based venture capital firm Blockchain Capital, told an interviewer last September that in 2013, he began looking at a lot of blockchain projects as potential investments. Many of those “purported that they’d be changing everything. … A lot of those projects have gone nowhere,” he said. At the blockchain world’s biggest conference in May 2018, he told attendees that most blockchain projects won’t fix the problems they aim to because they don’t eliminate the need for a trusted third party, according to news accounts of the event. Onstage, he bet another speaker, Joseph Lubin of blockchain giant Ethereum, that blockchain technology won’t have any significant use in five years. (It’s unclear if the bet was ever consummated.) Why is he a partner in a blockchain venture capital firm? He believes in blockchain’s use in powering Bitcoin but not much else.
Blockchains aren’t unhackable and can be breached if an outside entity gains control over at least 51 percent of the computing power. This is what happened to cryptocurrency Ethereum Classic in January, leading to the theft of more than $1 million worth of the currency, according to news reports. Though that was the first incident of its kind, it isn’t outside the realm of possibility that the development of quantum computing — tens of thousands to millions of times faster than current systems — could use its massive power to defeat a blockchain’s encryption. (Of course, quantum computing also would put our current centralized systems at risk.)
Death of a Middleman
But if Song is wrong and the proponents are prophets, blockchain applications will upend how transactions happen. Take real estate. Imagine logging in to your computer to access your credit data, which is stored on a blockchain. Your data are public — stored on thousands of computers — but no one can tell that those data are connected to you because your identity is protected by a strong cryptographic key that you control. And the data is near tamper-proof because it’s on a blockchain.
When applying for a home loan, borrowers can make their entire credit history — not just a score or snapshot — instantly available to lenders. Lenders bid, and the borrower picks the best deal. Increased competition and no more preapprovals or long loan applications, with lenders taking 30-60 days to make a decision.
That’s the scenario envisioned by Graham McBain, who directs the McClellan Innovation Center, cofounded Sacramento blockchain startup LayerOne and is a former real estate agent. (LayerOne has since been acquired by San Diego-based XYO Network but has an office at the McClellan Center. McBain is no longer with the company.)
Or consider real estate investment trusts, or REITs — companies that own, operate, or finance investment properties and let individuals buy shares. REITS work something like mutual funds for real estate. But those shares trade at less than their real value because of the uncertainties associated with bundling different properties, says Kevin Shtofman, national blockchain lead in the real estate practice of Deloitte Consulting. Instead, blockchain could let a property owner bypass a REIT and sell micro-shares directly to investors in the form of digital tokens, cutting out the intermediary REIT. “We can sell each development individually to investors, therefore unlocking more liquidity and hopefully increasing the value of the underlying asset,” he says.
Shtofman’s company has also mapped out a way that blockchain could speed up the existing title management system. A Deloitte report highlights a Ghanaian startup launching a land title registry to get all private land registered on a blockchain. When a property is being sold, a land surveyor uses GPS equipment to report the property’s boundaries. The title with those GPS coordinates and other details get recorded on the blockchain. As long as the original title is clear of defects, those time-stamped and unchangeable records remain secure and transparent forever.
A system like that would cut the number of errors in land titles — about 30 percent today, according to Goldman Sachs. Each of those mistakes requires a labor-intensive process to clear. Only titles that are clear of defects would get recorded on the blockchain. With all subsequent changes to the title recorded there, the amount of time that insurance companies would need to check a title would be cut significantly, says David Howie of Tellus Title Company, who works out of Placer County. Howie is out to create a kind of Dewey Decimal system for property on a blockchain, similar to the one Deloitte describes. “We think that we can make this whole process faster and more efficient and bring costs down, which can then ultimately be passed down to the consumer,” he says.
“We think that we can make this whole process faster and more efficient and bring costs down, which can then ultimately be passed down to the consumer.”
— DAVID HOWIE, CEO, TELLUS TITLE COMPANY
Title insurance companies are trying something similar to speed the title search process itself. One task in a title search on a property is to identify prior title insurance policies written for it — a time-consuming process that involves a lot of research. So in November 2018, First American Financial Corporation, one of the country’s largest title insurers, announced it was launching a blockchain to be shared among participating title insurers that contains all of their policies, thus “streamlining the search process and increasing the accuracy of searches for prior title insurance policies,” as the company put it in a release. (First American is keeping the details confidential, declining a request to speak for this story. The American Land Title Association, which represents insurers, also did not respond.)
All of this, say proponents, will dramatically cut the amount of time needed for a real estate transaction. “If everything is on the blockchain, closing could happen in six hours instead of 60 days,” claims Shtofman. With all of the relevant data for a sale on a trusted blockchain, Howie envisions a day not too distant when signing a contract on a house will involve clicking a “buy it now” button.
Still, in real estate some breakthrough blockchain ideas need buy-in from key partners, especially governments. Among the many blockchain initiatives that the XYO Network has in progress is a partnership, in its early stages, with real estate giant RE/MAX Mexico to build a blockchain-based land title registry. But its success depends critically on Mexican government agencies agreeing to participate. That’s by no means a guarantee. RE/MAX Mexico is working government channels now, says Justin Fortier, XYO’s point person for the project, who works out of the Sacramento office.
Other arenas may be more amenable if an intermediary is more easily replaced. In finance, for example, blockchain technology could let companies sell shares directly to customers instead of through a broker. “How hard would it be for Apple to tokenize their company, say in Apple Coins?” asks Beadles, of Monarch Wallet creater Splash Factory. That would kill the brokers and save customers a lot on transaction costs, he says.
The same pattern could hold with peer-to-peer lending, which now is enabled by web platforms like Prosper and LendingClub that pair investors with people and businesses looking for loans. With blockchain, lenders and borrowers would find each other on a blockchain and avoid the transaction fees charged by platforms. McBain says that already with cryptocurrency, “I can put [crypto] on the debt market, earning 3 percent a month lending it out on the blockchain. It’s peer-to-peer lending 3.0.”
“I can put [crypto] on the debt market, earning 3 percent a month lending it out on the blockchain. It’s peer-to-peer lending 3.0.”
— GRAHAM MCBAIN, DIRECTOR, MCCLELLAN INNOVATION CENTER
The Future Is … When?
Blockchains could bring all of that to pass, but the applications designed to run on them are still mostly described in future tense. And if a blockchain revolution is on the way, a generation of startups likely will have to fail first, much as happened with the dotcom bubble. A 2017 Deloitte analysis of more than 86,000 blockchain projects launched on the software collaboration platform GitHub concluded that only 8 percent were still going, with an average lifespan of just over a year. For example, in early 2015, the blockchain peer-to-peer lending platform BTCJam was listed by Business Insider as one of the 25 most exciting Bitcoin startups. Two years later it shut down, citing regulatory challenges.
Even the bullish Shtofman says that in real estate, intermediaries are going to be needed for the foreseeable future: attorneys for legal agreements, real estate agents for local knowledge, and title insurers to check a property’s provenance until a big group of proven-clean titles are loaded onto the blockchain. It’s hard to see how, in the short term, the scenario of a six-hour real estate sale could come to pass without eliminating time-consuming, in-person intermediary steps like a home inspection and attorney review of closing documents.
And many in the title insurance industry are skeptical that the new technology will ever significantly change the need for their services. The American Land Title Association argues that the number of quirky and obscure errors that can creep into a property’s title mean blockchain will never replace the need for human oversight. That “garbage-in” issue is known in the blockchain world as the “oracle problem,” says McBain, and there’s no easy solution.
Mass adoption also depends on familiarity and trust, and on that score, Beadles says there’s a long way to go. Monarch Wallet has 200,000 users, which seems like a lot until you consider that popular payment app Venmo has 18 million and PayPal 10 million. Most companies too are paying little attention, according to one study: In a 2017 survey of more than 3,000 chief information officers around the world by research and advisory company Gartner, 43 percent said blockchain was on the radar but that they had no plans to test it, and 34 percent said they had no interest. Beadles himself advises caution. Though Splash Factory helps firms build custom blockchain apps, he advises companies not to get into blockchain “just because it sounds cool. Unless you have a part of your business that requires immutability and transparency, you don’t need blockchain.”
If he’s right, companies have some options for educating themselves. Lots of books out there offer good blockchain overviews. XYO cofounder Markus Levin suggests attending one of the area’s several blockchain Meetup groups, buying a few shares of a blockchain company, or putting a few dollars into a cryptocurrency, which will force you to learn more about how it all works.