Blockchain explained: What it is and isn’t and why it matters

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Understanding how blockchain creates business value is essential for companies to identify the right use cases and move beyond small pilots to widespread adoption.

In this episode of the McKinsey Podcast, McKinsey partners Brant Carson and Matt Higginson speak with Simon London not only about how companies can drive business value through blockchain — but also how business leaders can determine when blockchain is and isn’t the right innovation.

Simon London: Hello, and welcome to this edition of the McKinsey Podcast with me, Simon London. Today we’re going to be talking about blockchain, the technology that underpins Bitcoin and other cryptocurrencies. As we’ll hear, blockchain has a lot of potential applications, in areas as diverse as supply-chain management, trade finance, insurance and even cybersecurity. But there are a lot of misconceptions and often good reasons why a blockchain may not be the right tool for the job. To help us understand the ins and outs, we’re joined by two McKinsey partners who are working closely with clients on these issues. They are Brant Carson, who’s based in Sydney, and Matt Higginson, who’s based in Boston. Brant and Matt, thanks so much for joining.

Brant Carson: You’re welcome.

Matt Higginson: You’re very welcome. Happy to be here.

Simon London: We should start with a quick level set to make sure everyone — notably me — understands what we’re talking about. Matt, would you mind kicking off by answering the beguilingly simple question, what is blockchain?

Matt Higginson: It’s a great question. And there have been many complicated explanations out there. The way I think about blockchain is really to think of it as a database. And it’s a database which is shared across a number of participants. We think about a network of participants. Each has a computer. The idea is that at any moment in time, simultaneously, each member of that network holds an identical copy of the blockchain database on their computer. That’s the essential principle. Information is potentially available to all participants at a moment in time.

When I think about that definition as a database, I think of it in three parts. The first is that this is a cryptographically secure database or distributed ledger. That means that when data is read or written from the database, you need the correct cryptographic keys to do that: a public key, which is a basically the address and the database where information is stored and a private key, which is your personal key, truly the security which prevents other people from updating the information unless they have that correct key. It’s secure data.

Second, it’s a digital log or digital database of transactions. Digital’s important because, in many industries, we’re still going through the process of digitization and that’s an important first step before you can even think about using blockchain.

Finally, this is a database that’s shared across either a public or a private network. The most famous public network is probably the Bitcoin blockchain. That is something which has been around for many years. And you can join that network. You can become a node on the network with a computer, without any expressed permissions. And you can leave again. So no one really knows who’s joining and leaving.

Conversely, you can have a private blockchain, a private network, which in an application like banking is probably much more culturally acceptable, in which you know who’s participating, who’s got access to data, who’s holding a copy of that database.

Simon London: That was very useful. But as a layperson, I’m thinking, well, we already have big databases. And we already have the cloud, where you can share big databases and manage permissions. So just double click for us, why is blockchain potentially a better mousetrap?

Matt Higginson: This is the core to answering many questions about why blockchain should be used. Four areas of innovation here.

One certainly revolves around the cryptographic keys. The cryptographic security we’re using today that was originated in the Bitcoin blockchain truly comes from 20-plus years of cryptographic research. This wasn’t just invented overnight. The way of securing data in a distributed database through these keys is pretty unique and certainly uses cutting-edge securities. That’s number one.

Second, the idea that this is a distributed, a decentralized, database means that you don’t have some of these issues around a database breaking the single point of failure. What you’ve actually got is a system which is very robust. If one database fails, one copy fails, you’ve got that important redundancy across multiple nodes.

Third, the essence of blockchain is a chain of blocks of information together. When you have those blocks chained together, you’re creating a perfect audit history. You can go back through time and see a former state of the database. If you’re recording things like property titles, you can see a previous owner of the property and the current owner. You’ve got this perfect audit trail.

But perhaps the most important aspect here, and this is what’s getting people excited, is this idea of process integrity. And that is the database can only be updated when two things happen. One, the correct credentials are being applied, the private and public key together.

But most importantly, those credentials are being verified by a majority of participants in the network. You can only update the database when the majority of independent computers check and verify those credentials that allow you to write to the database. You’re securing this against the idea of single point of failure and somebody working nefariously to try and corrupt the database. You have this democratization of the process of dating the database.

Simon London: Brant, let me bring you in there. If you’re out at a dinner party, and you mention that you work in blockchain, what kind of responses do you get? And what do you hear are the misconceptions about it?

Brant Carson: There are a lot of misconceptions (Exhibit 1). A lot of people have heard of blockchain but really don’t understand quite what it is. You hear everything, from everybody thinking that blockchain is Bitcoin or vice versa through to “it’s a ‘truth’ machine unto itself.”

Is blockchain Bitcoin? No, as Matt was just saying, Bitcoin is an implementation of andleverages a blockchain in order to deliver a virtual currency. We often hear, “Is it better than traditional databases?” No, it’s not necessarily better than traditional databases. But blockchain is very effective in an environment where you need to have a decentralized way of working or you’re looking to take out a centralized entity — so in things like in trade finances.

That said, I mean, blockchain isn’t as efficient as traditional databases. It’s much hungrier in terms of energy use and in many cases has higher storage costs. By definition, it’s much more for specific use cases.

Is it immutable or tamper-proof? It is only as immutable and tamper-proof as the implementation itself. And, frankly, if you’re able to take over half the nodes in a blockchain network, it’s very difficult. But if you are, you can tamper with it because then you will be able to affect the consensus algorithm.

As far as it being a truth machine, well, the blockchain’s only as good as the information you put in it. So if you have a blockchain, and in the blockchain you’re keeping people’s driver’s license information or voting history, and you put in incorrect data, the data itself isn’t checked in any particular way. All that the blockchain itself does is ensure the integrity of the individuals making the transaction, ensuring that you have the right combination of a public and private key.

Matt Higginson: I would just add a couple of thoughts on that. I agree with you entirely, Brant. I think one of the confusions over having a coin like Bitcoin is this idea that there’s inherent monetary value.

When we think about the original purpose, it was to reward the computers, the people doing the work, actually doing the verification process. And so a coin was important to provide monetary compensation for, in that case, the electricity being used to do the vast amounts of computation.

When we look to implementations of blockchain going forward, very rarely is it necessary to have a coin or some sort of reward. Instead the reward is access to data. If you think about a private blockchain, a closed-loop network of computers, all pursuing the same eventual goal, let’s say it’s in insurance or trade finance, then the reward is being part of that club, that private network. And, frankly, the reward is also being better able to share data and therefore generate better business processes.

Simon London: One of the things that strikes me is that a lot of people are drawn to Bitcoin because you’re doing away with the central authority, the central banks in that case. Is disintermediation central to how a blockchain creates value?

Brant Carson: Yes, absolutely, disintermediation is one of the ways it creates value, in that you don’t have a central authority. It does make things like trade finance much simpler because you don’t have intermediaries along the way. There’s a very good example: the UN, delivering some of their aid to Syria, has used a blockchain-based solution.

And by doing that, they’ve been able to actually authenticate individuals using biometric data and use that as a way to ensure that the aid give is given to the right people and it’s an equitable quantity.

This is a very clean way of taking out what would be traditionally money that would follow multiple steps and transaction costs to get to the end users. But there are also many other reasons why blockchain is effective. That is only one of multiple different sources of value.

Matt Higginson: I think the principle of disintermediation was a good one, in that the idea of democratization of data, streamlining processes, taking away the central agency power that could actually corrupt how data is being written and recorded permanently. When we looked at the practical applications today, and I’m sure we’ll talk more about that, the real irony in some ways is that in order to justify significant investment in this new technology, you actually need somebody to take a leading role very often.

You need someone to stand up and say, “I’m going to be the pioneer. I’m going to develop the platform. And perhaps I’ll bring industry partners in. But I’m doing this potentially because the business case says it gives me competitive advantage.”

The irony is, in those use cases where that makes more sense, the developers actually tend to be thinking in a more defensive way: “I already hold a central role in whatever ecosystem I’m playing in, and blockchain presents potentially a better solution.”

One example would be somebody who’s certifying the quality of a supply chain. Organic foods, non-GMO foods. In that case you might think of blockchain as providing the source of truth, the real gold-standard details of a supply chain. But the agencies who are developing it still want to hold that central role as being the authority on saying, “Yeah, this food is organic. And we can track it down the supply chain.” It’s a little bit of an irony or a contradiction there. Truly, it’s about disintermediation, but at the same time, those who are investing in the space think of it as a defensive play to strengthen their position in the center of an ecosystem.

Simon London: So I would guess you’re both out talking to clients a lot of the time about whether they should invest and how to invest. What are you hearing in terms of how are they thinking about it? How are they thinking about the value equation?

Matt Higginson: Frankly, it’s not all the purist view, which is, blockchain is solving industry problems, and this is the new world. There are three camps or categories of ways that companies are thinking about value.

One is that purist or academic value, which is, there are intrinsic properties of blockchain, which — this goes to the point about being a better mousetrap — really do solve industry problems. They provide a way of sharing data securely across multiple parties. Things like supply chain or trade finance would be absolutely perfect for that camp.

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