The Big Blockchain Question
-By Bob Needham
Earlier this year, Michigan Ross hosted an event for alumni in Los Angeles that went viral online. The featured attraction: Scott DeRue, the Edward J. Frey Dean, conducting a public interview with Charlie Munger — one-time University of Michigan student, vice chairman of Berkshire Hathaway, highly successful investor, Warren Buffett partner, and respected business guru.
Shuffling through index cards submitted by the packed audience, DeRue drew a laugh as he noted, “Half my questions here are about Bitcoin and cryptocurrency.”
“Well, I can answer those very quickly,” Munger responded. “I think it’s perfectly asinine to even pause to think about them.” Warming to the subject, he expressed skepticism about the technology’s safeguards against abuse, then went even further: “It’s luring people into the concept of easy wealth without much insight or work … It’s totally insane.”
Yet the topic is unavoidable: New cryptocurrencies are popping up. The industry has started a lobbying operation in Washington, D.C. Entrepreneurs are pushing new uses for the underlying technology. And a video of Munger’s interview on the Michigan Ross YouTube channel racked up more than 100,000 views, plus countless thousands more on other sites.
The concept’s biggest supporters and critics both seem to agree on at least two things: There are a lot of unknowns, and there’s a lot at stake.
Blockchain 101: What Is It, Exactly?
So how should someone try to start making sense of it all? First, some important basic concepts:
Virtual currency in the online realm. Independent of any government or regulation, it’s worth whatever the market says it is. There are many different competing cryptocurrencies.
The most popular and best-known cryptocurrency. Its price shot up last year — from less than $1,000 to more than $15,000 — only to spend much of this year dropping. Ether and Ripple are among the better-known competitors.
The technology that underlies cryptocurrencies. This is where it starts to get complicated, but the main things to know are that it’s essentially a way to store encrypted data, and that access — and the ability to make changes — is controlled jointly by all the users. The general concept is called “distributed ledger” or “immutable ledger” technology.
Questions About Cryptocurrencies
Cryptocurrencies are the most obvious, and so far the most popular, application of blockchain. Supporters believe that it’s more secure than other methods of electronic financial transactions. This appeal has generated intense interest from those hoping to invest early in a potentially world-changing technology.
Bitcoin, the most popular cryptocurrency, has generated tremendous hype over the last couple years. It promised a completely secure way to make financial transactions online, untroubled by regulation or oversight. Investors loved the idea, and prices skyrocketed — at first.
Questions quickly emerged — is Bitcoin more a currency or a commodity? The process of “mining” new Bitcoin is complicated and obtuse; it also requires a great deal of computing power and energy consumption. Some say the community of users controls the process, but it does so with no regulation or oversight. Additionally, merchants have been slow to accept Bitcoin as a payment method.
In an essay in the online magazine The Hill late last year, Andrew Wu — an assistant professor of finance and technology and operations at Michigan Ross — urged extreme caution to anyone considering investing.
“From the merchants’ perspective, the extreme volatility of Bitcoin makes it a poor working capital solution and an accounting nightmare. This seems to defeat Bitcoin’s original promise as a means of cashless transaction,” Wu wrote. “So what are investors betting on, then? Speculative psychology. The main reason to buy Bitcoin seems to be the hope that, somewhere down the road, exists some poor schmuck willing to buy it for more money.”
Ross Professor of Finance Robert Dittmar explained, “Your basic macro textbook tells you what counts as a form of currency — something that provides stable value and is readily accepted as a means of exchange. Cryptocurrencies fail that definition. Obviously their prices in exchange for dollars are extremely volatile, and in addition, not everybody is accepting them as a form of payment. And so they do a bad job of being a real form of payment per se.” In addition, he said, it’s currently a lot easier to buy Bitcoin than it is to sell it for the supposed current price.
Dittmar, along with Wu, teaches a FinTech Innovations class at Ross. The two are also conducting research into companies that use cryptocurrency releases as a way to raise capital.
“The way that I look at cryptocurrencies is that they're acting more like a virtual commodity at this point,” Dittmar said. “Something is worth what you believe it's worth, so in that sense a cryptocurrency isn’t that much different than gold.”
One difference, however, is that commodities are regulated. “Because Bitcoin is just completely unregulated at this point, issues of market manipulation and so on become a real concern,” Dittmar said. “People who may not know exactly what they’re doing can potentially get themselves into some real trouble in these kinds of things.”
At the alumni event in LA, Charlie Munger also questioned the underlying security of Bitcoin. “It’s one thing to think that gold has some marvelous value because man has no way of getting more gold or getting it very easily. So it has the advantage of rarity. Believe me: Man is capable of somehow creating more Bitcoin,” Munger told the audience. “They tell you they’re not going to do it. But that means they’re not going to do it unless they want to … When there’s enough incentive, bad things will happen.”
Potential for Other Uses
Bitcoin, however, is far from the only cryptocurrency. Ether, built on a blockchain platform called Ethereum, and Ripple are probably the next-best-known types. However, new versions of cryptocurrency come along regularly, with different features and structures.
Blockchain is the technology underlying these different cryptocurrencies. The concept gets its name from the computer code behind it, which literally consists of a chain of digital blocks of data. It’s set up so that no individual can change the information; it’s jointly controlled by the entire group of users, and there’s a record of all changes. While using that technology for digital currency was the first widespread application, other uses may offer greater potential.
As the chief operations and technology officer at Bank of America, Catherine Bessant, BBA ’82, clearly sees both the limitations and the potential of blockchain technology. Bessant was recently named the most powerful woman in banking for the second straight year.
“I think of cryptocurrency in three ways – the ‘asset class’ of cryptocurrency, its use as a payment vehicle, and as a technology platform. As an investment, that’s a decision for investors. As money to be paid or received, it’s an anathema that goes against the foundation of financial institutions and violates the transparency between sender and receiver that we strive to maintain,” she said. “As a technology, we’re looking for ways to harness its value.”
Those ways might include record keeping, clearing and settlement, digital identity, multi-party aggregation, reinsurance, and more, Bessant said; Bank of America currently has 89 blockchain-related patents and applications. “Virtually any asset of value can be tracked and traded on a blockchain network, which can help reduce risks and cut costs for all involved,” she said. “It’s a great technology, we’ve just got to find the right business use for it.”
That use will capitalize on the particular advantages of blockchain. Ross Professor Dittmar said the technology boasts two key advantages: integrity, or immutability, of the data; and decentralization. Security is an important advantage of blockchain, he said, although it’s not as guaranteed as some like to believe. Users have keys, like passwords, and some can be stronger than others.
The decentralization aspect is powerful, Dittmar said: “Let's say you had two different hospitals that had to interact in some kind of way. Oftentimes the problem that we have is that recordkeeping in one hospital is done on some completely different system than recordkeeping in another hospital. In principle, a blockchain-based system could allow both hospitals to retain their own recordkeeping systems, but talk to one another across a blockchain-based system. And that has potentially interesting applications in lots of places.”
Dittmar sees parallels to the initial dot-com bubble of the late 1990s. “It’s this technology that seems to have a ton of potential behind it, but I also see lots of smoke and mirrors – people saying, ‘Ooh, blockchain.’ If you put blockchain in your name, all of a sudden your stock price will go up. There are a lot of applications in which it is unclear why it's much different than using a database, and I think that that’s where the question still lies.”
A Ross Alum Makes It Work
While blockchain technology hasn’t been widely adopted yet, individuals are already finding ways to use it effectively. For example: John Kang, MBA ’10, recently launched Reasi, a real estate escrow company based on blockchain. The company completed its first deal in August, and Kang is using blockchain as its financial backbone.
“My company is an online peer-to-peer real estate escrow company, and blockchain reduces transaction friction and improves security,” Kang said. “Blockchain has the potential to displace many financial institutions from the functions they traditionally perform (think payments, escrow, lending). A P2P, blockchain approach translates into substantial cost savings for the masses.
“More broadly, many industries/applications can benefit from an immutable and fully accountable ledger. Beyond finance, an immutable ledger could be invaluable for medical records, chain of ownership and fractional ownership of assets (digital particularly), voting, insurance, and supply chain, among others.”
Even Kang, though, sees limitations and has outstanding questions, including the need for regulation and the concentration of crypto wealth among a small number of owners.
“Scalability is the largest issue, although it should be solvable,” Kang said. “Decentralization comes at a processing power cost, and the computational speeds just aren't there yet. A few months ago, just one Ethereum decentralized application, Cryptokitties, essentially crashed the entire global network — imagine if there are thousands of these decentralized apps?”
What’s Next — And How to Get Ready
Students like Rishi Prasad, BBA ’20, will likely play a major role in how the blockchain story develops. Prasad founded the Michigan FinTech club, and is cofounder and president of its offshoot Wolverine Blockchain. He’s already seen high demand among potential employers for students with knowledge of blockchain and related subjects. He too understands both the potential and the limitations of the technology and its future.
“My view is that it depends in part on the maturity of the technology we will see in the next few years, but far more on people’s reaction to it — which is hard to predict. The overpromotion of blockchain as a universal solution has led to many misconceptions about the technology and can create confusion in the effort to determine what the technology can actually solve,” Prasad said. “It's still early days for this space, but there are some incredibly smart, intelligent and driven individuals — developers, venture capital firms, enterprises, and financial institutions — working on improving this ecosystem.”
So what should an interested business person do? Follow the latest news. Learn as much as possible from trusted sources. Try to figure out where the technology might truly offer a solution for your business. If you invest, do so carefully.
“Buy a small amount of Bitcoin,” Kang recommended. “I always believe you learn faster when you have a stake. Watch Youtube videos and get very familiar with the strategic benefits and concepts — P2P, decentralization, immutability, security. Take online training courses, particularly on the technology development if you’re a coder.”
Bessant agreed that educating oneself is important: “While true blockchain functionality will not exist in the immediate future, most large financial institutions are already looking at multiple use cases,” she said. “I participated in an enriching discussion in May on this exact topic at a Michigan Ross roundtable event in New York City. Continuing to stay up to date on emerging technology is critical to understanding their near- and/or long-term application and impacts.”
Dittmar summarized a lesson he emphasizes in class: “As business students, your comparative advantage is probably not in terms of designing some new blockchain-based solution. Your comparative advantage is understanding why it’s a good solution to a particular business problem. That's really what people need to weigh,” he said. “If I know very well what blockchain does, then I can say, ‘Yes, this seems to be a smart solution to the challenge we face.’”