What is blockchain?
Blockchain is a secure database shared across a network of participants,
where up-to-date information is available to all participants at the same time.
This is clearly a winning
choice for the graduates as companies have faced serious supply chain and
manpower shortages after the pandemic. The global industrial robotics market
was $14.7 billion in 2020 and is expected to grow to $32 billion by the end of
2028. Also, small- and mid-sized tech companies continue to leapfrog in
capabilities and time, thus enabling routine business processes to become
automated.
Blockchain is
one of the major tech stories of the past decade. Everyone seems to be talking
about it—but beneath the surface chatter there’s not always a deep clear
understanding of what blockchain is or how it works. Despite its reputation for
impenetrability, the basic idea behind blockchain is pretty simple. And it has
major potential to change industries from the bottom up.
Blockchain is a technology that
enables the secure sharing of information. Data, obviously, is stored in a
database. Transactions are recorded in an account book called a ledger. A
blockchain is a type of distributed database or ledger—one of today’s top tech
trends—which means the power to update a blockchain is distributed between the
nodes, or participants, of a public or private computer network. This is known
as distributed ledger technology, or DLT. Nodes are incentivized with digital
tokens or currency to make updates to blockchains.
Blockchain allows for the
permanent, immutable, and transparent recording of data and transactions. This,
in turn, makes it possible to exchange anything that has value, whether that is
a physical item or something less tangible.
A blockchain has three central
attributes. First, a blockchain database must be cryptographically secure. That
means in order to access or add data on the database, you need two
cryptographic keys: a public key, which is basically the address in the
database, and the private key, which is a personal key that must be
authenticated by the network.
Next, a blockchain is a digital
log or database of transactions, meaning it happens fully online.
And finally, a blockchain is a
database that is shared across a public or private network. One of the most well-known
public blockchain networks is the Bitcoin blockchain. Anyone can open a Bitcoin
wallet or become a node on the network. Other blockchains may be private
networks. These are more applicable to banking and fintech, where people need
to know exactly who is participating, who has access to data, and who has a
private key to the database. Other types of blockchains include consortium
blockchains and hybrid blockchains, both of which combine different aspects of
public and private blockchains.
Research from the McKinsey
Technology Council suggests that by 2027, up to 10 percent of global GDP could
be associated with blockchain-enabled transactions. But in the world of
blockchain, what is real and what is just hype? And how can companies use
blockchain to increase efficiency and create value? Read on to find out.
How does blockchain work?
A deeper dive may help in
understanding how blockchain and other DLTs work.
When data on a blockchain is
accessed or altered, the record is stored in a “block” alongside the records of
other transactions. Stored transactions are encrypted via unique, unchangeable
hashes, such as those created with the SHA-256 algorithm. New data blocks don’t
overwrite old ones; they are appended together so that any changes can be monitored.
And since all transactions are encrypted, records are immutable—so any changes
to the ledger can be recognized by the network and rejected.
These blocks of encrypted data
are permanently “chained” to one another, and transactions are recorded sequentially
and indefinitely, creating a perfect audit history that allows visibility into
past versions of the blockchain.
When new data is added to the
network, the majority of nodes must verify and confirm the legitimacy of the
new data based on permissions or economic incentives, also known as consensus
mechanisms. When a consensus is reached, a new block is created and attached to
the chain. All nodes are then updated to reflect the blockchain ledger.
In a public blockchain network,
the first node to credibly prove the legitimacy of a transaction receives an
economic incentive. This process is called “mining.”
Here’s a theoretical example to
help illustrate how blockchain works. Imagine that someone is looking to buy a
concert ticket on the resale market. This person has been scammed before by
someone selling a fake ticket, so she decides to try one of the
blockchain-enabled decentralized ticket exchange websites that have been
created in the past few years. On these sites, every ticket is assigned a unique,
immutable, and verifiable identity that is tied to a real person. Before the
concertgoer purchases her ticket, the majority of the nodes on the network
validate the seller’s credentials, ensuring that the ticket is in fact real.
She buys her ticket and enjoys the concert.
What is proof of work and how is it different from proof
of stake?
Remember the idea of consensus
mechanisms mentioned earlier? There are two ways blockchain nodes arrive at a
consensus: through private blockchains, where trusted corporations are the
gatekeepers of changes or additions to the blockchain, or through public,
mass-market blockchains.
Most public blockchains arrive
at consensus by either a proof-of-work or proof-of-stake system. In a
proof-of-work system, the first node, or participant, to verify a new data
addition or transaction on the digital ledger receives a certain number of
tokens as a reward. To complete the verification process, the participant, or
“miner,” must solve a cryptographic question. The first miner who solves the
puzzle is awarded the tokens.
Originally, people on various
blockchains mined as a hobby. But because this process is potentially
lucrative, blockchain mining has been industrialized. These proof-of-work
blockchain-mining pools have attracted attention for the amount of energy they
consume.
In September 2022, Ethereum, an
open-source cryptocurrency network, addressed concerns around energy usage by
upgrading its software architecture to a proof-of-stake blockchain. Known
simply as “the Merge,” this event is seen by cryptophiles as a banner moment in
the history of blockchain. With proof-of-stake, investors deposit their crypto
coins in a shared pool in exchange for the chance to earn tokens as a reward.
In proof-of-stake systems, miners are scored based on the number of native
protocol coins they have in their digital wallets and the length of time they
have had them. The miner with the most coins at stake has a greater chance to
be chosen to validate a transaction and receive a reward.
How can businesses benefit from blockchain?
Research suggests that
blockchain and DLTs could create new opportunities for businesses by decreasing
risk and reducing compliance costs, creating more cost-efficient transactions,
driving automated and secure contract fulfillment, and increasing network
transparency. Let’s break it down further:
Reduced risk and lower
compliance costs. Banks rely on “know your customer” (KYC) processes to bring
customers on board and retain them. But many existing KYC processes are
outdated and drive costs of as much as $500 million per year, per bank. A new
DLT system might require once-per-customer KYC verification, driving efficiency
gains, cost reduction, and improved transparency and customer experience.
Cost-efficient transactions.
Digitizing records and issuing them on a universal ledger can help save
significant time and costs. In a letter-of-credit deal, for example, two
companies opted for a paperless solution and used blockchain to trade nearly
$100,000 worth of butter and cheese. By doing so, a process that previously
took up to ten days was reduced to less than four hours—from issuing to
approving the letter of credit.
Automated and secure contract
fulfillment. Smart contracts are sets of instructions coded into tokens issued
on a blockchain that can self-execute under specific conditions. These can
enable automated fulfillment of contracts. For example, one retailer wanted to
streamline its supply-chain-management efforts, so it began recording all
processes and actions, from vendor to customer, and coding them into smart
contracts on a blockchain. This effort not only made it easier to trace the
provenance of food for safer consumption but also required less human effort
and improved the ability to track lost products.
How are blockchain, cryptocurrency, and decentralized
finance connected?
Blockchain enables buyers and
sellers to trade cryptocurrencies online without the need for banks or other
intermediaries.
All digital assets, including
cryptocurrencies, are based on blockchain technology. Decentralized finance
(DeFi) is a group of applications in cryptocurrency or blockchain designed to
replace current financial intermediaries with smart contract-based services.
Like blockchain, DeFi applications are decentralized, meaning that anyone who
has access to an application has control over any changes or additions made to
it. This means that users potentially have more direct control over their
money.
What else can blockchain be used for?
Cryptocurrency is only the tip
of the iceberg. Use cases for blockchain are expanding rapidly beyond
person-to-person exchanges, especially as blockchain is paired with other
emerging technology.
Examples of other blockchain use cases include the
following:
With blockchain, companies can
create an indelible audit trail through a sequential and indefinite recording
of transactions. This allows for systems that keep static records (of land
titles, for example) or dynamic records (such as the exchange of assets).
Blockchain allows companies to
track a transaction down to its current status. This enables companies to
determine exactly where the data originated and where it was delivered, which
helps to prevent data breaches.
Blockchain supports smart
contracts, which are programs that trigger transactions automatically upon
fulfillment of contract criteria.
What are some concerns around the future of blockchain?
While blockchain may be a
potential game changer, there are doubts emerging about its true business value.
One major concern is that for all the idea-stage use cases, hyperbolic
headlines, and billions of dollars of investment, there remain very few
practical, scalable use cases of blockchain.
One reason for this is the
emergence of competing technologies. In the payments space, for example,
blockchain isn’t the only fintech disrupting the value chain—60 percent of the
nearly $12 billion invested in US fintechs in 2021 was focused on payments and
lending. Given how complicated blockchain solutions can be—and the fact that
simple solutions are frequently the best—blockchain may not always be the
answer to payment challenges.
Looking ahead, some believe the
value of blockchain lies in applications that democratize data, enable
collaboration, and solve specific pain points. McKinsey research shows that
these specific use cases are where blockchain holds the most potential, rather
than those in financial services.
How might blockchain evolve over time?
In the next five years,
McKinsey estimates that there will be two primary development horizons for
blockchain:
Growth of blockchain as a
service (BaaS). BaaS is a cloud-based service that builds digital products for
DLT and blockchain environments without any setup requirements for
infrastructure. This is currently being led by Big Tech companies.
Interoperability across
blockchain networks and outside systems. Increased interoperability will mean
that disparate blockchain networks and external systems will be able to view,
access, and share one another’s data while maintaining integrity. Hardware
standardization and scalable consensus algorithms will enable cross-network use
cases—such as the Internet of Things on blockchain infrastructure.
These trends will be enabled
partly because of increased pressure from regulators and consumers demanding
greater supply chain transparency, and partly because of economic uncertainty,
as consumers seek out independent, centrally regulated systems. And large
corporations launching successful pilots will build confidence for consumers
and other organizations.
Potential growth could be
inhibited by a few factors: for one, several well-known applications have
inherently limited scalability, including energy or infrastructure
requirements. Further, uncertainty about regulatory or governance developments
could keep consumers shy—for instance, if there is a lack of clarity on who
will enforce smart contracts. And, finally, the unresolved threat of
cyberattacks remains a fear for potential blockchain users.
What do NFTs have to do with blockchain?
Nonfungible tokens (NFTs) are
minted on smart-contract blockchains such as Ethereum or Solana. NFTs represent
unique assets that can’t be replicated—that’s the nonfungible part—and can’t be
exchanged on a one-to-one basis. These assets include anything from a Picasso
painting to a digital lolcat meme. Because NFTs are built on top of
blockchains, their unique identities and ownership can be verified through the
ledger. With some NFTs, the owner receives a royalty every time the NFT is
traded.
The NFT market is extremely
volatile: in 2021, one NFT created by the digital artist Mike Winkelmann, also
known as Beeple, was sold at Christie’s for $69.3 million. But NFT sales have
shrunk dramatically since summer 2022.
How secure is blockchain?
Blockchain has been called a
“truth machine.” While it does eliminate many of the issues that arose in Web
2.0, such as piracy and scamming, it’s not the be-all and end-all for digital
security. The technology itself is essentially foolproof, but, ultimately, it
is only as noble as the people using it and as good as the data they are adding
to it.
A motivated group of hackers
could leverage blockchain’s algorithm to their advantage by taking control of
more than half of the nodes on the network. With this simple majority, the
hackers have consensus and thus the power to verify fraudulent transactions.
In 2022, hackers did exactly
that, stealing more than $600 million from the gaming-centered blockchain
platform Ronin Network. This challenge, in addition to the obstacles regarding
scalability and standardization, will need be addressed. But there is still
significant potential for blockchain, both for business and society.
For a more in-depth exploration
of these topics, see McKinsey’s “Blockchain and Digital Assets” collection.
Learn more about McKinsey’s Financial Services Practice—and check out
blockchain-related job opportunities if you’re interested in working at
McKinsey.
Articles
referenced include:
·
“McKinsey
Technology Trends Outlook 2022,” August 24, 2022
·
“Forward
Thinking on tech and the unpredictability of prediction with Benedict Evans,”
April 6, 2022, Janet Bush and Michael Chui
·
“Seven
technologies shaping the future of fintech,” November 9, 2021, Dick Fong,
Feng Han, Louis Liu, John Qu, and Arthur Shek
·
“CBDC
and stablecoins: Early coexistence on an uncertain road,” October 11, 2021,
Ian De Bode, Matt
Higginson, and Marc Niederkorn
·
“Blockchain
and retail banking: Making the connection,” June 7, 2019, Matt
Higginson, Atakan Hilal, and Erman Yugac
·
“Blockchain
2.0: What’s in store for the two ends—semiconductors (suppliers) and
industrials (consumers)?,” January 18, 2019, Gaurav Batra, Rémy Olson,
Shilpi Pathak, Nick Santhanam, and Harish Soundararajan
·
“Blockchain’s
Occam problem,” January 4, 2019, Matt
Higginson, Marie-Claude
Nadeau, and Kausik Rajgopal
·
“Blockchain
explained: What it is and isn’t, and why it matters,” September 28, 2018
Regards!
Librarian
Rizvi Institute of Management
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