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What CIOs Should Tell the Board of Directors About Blockchain Published: 14 February 2017 ID: G00323592

Analyst(s): David Furlonger, Jorge Lopez, Ray Valdes

Many boards of directors will call upon their CIOs to brief them on blockchain due to the current market hype. CIOs should focus on three points: a description of blockchain, frictionless markets and the cross- industry business impacts of a programmable economy.

Key Challenges ■ Most board directors have heard about blockchain, but few understand the technology and its

implications for business.

■ Many CIOs will have to explain the strategic implications of blockchain without getting bogged down in technical details.

■ Blockchain could create cross-industry, transparent and frictionless markets (where transactions have almost no costs and restraints); however, the future business climate, risks and legal status of blockchain remain unclear.

Recommendations CIOs looking to build or expand a digital business:

■ Propose that the board commission a scenario-planning exercise by engaging senior executives to map out how three possible futures for blockchain will affect the enterprise's business.

■ Advise the board to take a hard look at the company's value chain and its sustainability by analyzing which parts would need to change as blockchain propels a transition to frictionless market.

■ Introduce to the board a plan to conduct a fresh business and competitor analysis by taking into account the business dynamics and risks that smart contracts and blockchain make possible.

■ Encourage innovation by organizing visits to at least five blockchain startups related to your industry in the next six months, so that you can more effectively update the board on cross- industry blockchain developments.

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Introduction Gartner's 2016 Board of Directors Survey found that 91% of board directors have heard of blockchain/distributed ledger technology. Thirty-six percent viewed it as an opportunity; 21% viewed it as a threat. However, our interactions with executives indicate that most directors don't know much about distributed ledger technology. CIOs should expect to be invited soon to a board meeting to explain the implications of blockchain for the enterprise and its industry, or CEOs will ask the CIO what they should tell the board about blockchain. To start, board directors won't want a lot of detail, just the high-level issues, implications and suggested actions (see Figure 1):

Figure 1. Blockchain Brings a New Paradigm to Transaction Exchange and Trust

Source: Gartner (February 2017)

Analysis

Directors Need to Imagine Competing in Frictionless Markets

CIOs should start their presentation by asking the board to envision what-if strategic possibilities. What if it were possible for markets to become frictionless? Set out all the elements of conducting trade between two or more counterparties in the company's value chain. Then ask, what would happen to the business if people, business and smart things did not have to resort to a third party to establish trust and arrange payment as in current economic models. Suppose every party could determine who it can trust on its own and establish computer-generated contracts with them to reflect that engagement, and then, exchange value directly with any other counterparty on the

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network, without recourse to an intermediary. Moreover, the payment wouldn't have to take the form of a government-backed currency, but could be a digital currency (such as bitcoin) or even involve barter — for example, trading data for a digital service, or integrating credit provision and reward mechanisms as part of the cryptocurrency itself.

A world of decentralized trust and frictionless markets would:

■ Democratize value creation and exchange — Small companies can more easily compete with big ones across broad commercial ecosystems supported by platform businesses (see "Building a Digital Business Technology Platform"). Market entry is accelerated, perhaps at the expense of incumbents.

■ Combine or eliminate more markets if new trusted relationships can be established faster.

■ Create and cultivate new markets and business ecosystems, and increase potential market growth exponentially via the economics of connections and shifting of value to other industry segments (see "Unlock Digital Business Value Through the Economics of Connections").

■ Enable rapid scaling of new digital businesses models.

■ Provide transparent information about commercial interactions where there is a secure, immutable "golden record" of activity.

CIOs should present frictionless markets as an aspiration, rather than a near reality. Through at least 2035, there will always be some friction. For example, a key barrier to adoption of cryptocurrency is the generally horrible use experience and cumbersome security measures needed to manage private keys so that wallets aren't compromised and funds stolen. Businesses (such as Best Buy or Expedia) that accept bitcoin find that less than one-tenth of one percent of revenue comes from those channels. Currently, smart contracts are cumbersome to implement, unable to scale and open to significant legal questions.

Recommendation ■ Advise the board to take a hard look that the company's value chain and its sustainability by

analyzing which parts would need to change as blockchain propels a transition to frictionless market (see "A Simple Framework to Translate IT Benefits Into Business Value Impact").

Explain Why the Board Should Further Investigate Blockchain

The technology to make frictionless markets possible already exists, albeit in limited form: distributed ledgers such as blockchain. Distributed ledgers consist of an expandable list of cryptographically signed, irrevocable records of transactions, and stored, natively created value shared by all participants in a distributed network of computers. Trust occurs via a consensus mechanism in which computers on the network check each other to ensure records are consistent — no need for a money center bank or central settlement mechanism. Thus, the system enables people to create, transfer and store value directly, without involvement of a central authority or intermediary organization.

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Blockchain's potential benefits include:

■ Civilians and computerized agents govern the economic and transaction infrastructure, which is global in scale, peer-to-peer, self-regulating, secure and reliable.

■ A decentralized, shared history of activity, obligations, rights and records ensures transparency and certainty.

■ Fine-grained and diverse (not just monetary) value exchange occurs directly between participants to a network, at lower cost and higher speed compared to legacy systems.

■ The system is open to everyone, both public and private, but control and openness can be customized.

■ Ownership and rights are recognized broadly. Value can be natively created and exchanged, with no double spending or repudiation of transactions. The system guarantees proof of existence, process and asset provenance.

■ Embedded business logic enables dynamically self-executing smart contracts linked to diverse assets. Distributed autonomous organizations acting as full-fledged legal entities can execute transactions with no human intervention.

With these capabilities, blockchain makes possible "instant" business models created to exploit temporary opportunities, often using parties the enterprise hasn't done business with before. At the same time, old business models could be disintermediated by the next Airbnb, Uber or Amazon. Intermediation via decades- or centuries-old organizations would disappear.

Recommendations ■ Introduce to the board a plan to conduct a fresh business and competitor analysis by taking into

account the business dynamics and risks that smart contracts and blockchain makes possible (see "Maverick* Research: The Programmable Economy Is the Ultimate Destination for Digital Business").

■ Take the opportunity to introduce to the board the concepts, risk and opportunities concerning artificial intelligence and autonomous or algorithmic business. The biggest disruptions to the enterprise's business will not come from traditional competitors, but from companies outside the market that use these capabilities to change economic models or even eliminate markets.

Warn the Board Not to Underestimate the Impact of Blockchain

Enterprises run the risk of having their business disrupted if they do nothing about blockchain; however, undertaking a blockchain initiative carries risks, too. CIOs should mention three areas where blockchain will affect the board's risk calculations: business climate, risk management and legal issues.

Business climate: Blockchain will reinforce these trends, which digital business has already created:

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■ Enterprises will find it easier to expand their markets, either by entering blue-ocean spaces or enlarging their existing ecosystems of suppliers and partners.

■ Blockchain will offer opportunities to dramatically lower costs, especially where transactions occur in a wholly digital space.

■ Blockchain will sow confusion in multiple industries, perhaps especially (but not exclusively), financial services; however, most industry boundaries will become more fluid. Fewer enterprises can be sure what business they will be in five years, and blockchain boosts the disruptive capacity of new entrants unencumbered by legacy.

■ Financial regulators, banks and other institutions that oversee today's financial architecture will not know what to do about blockchain, so they will hesitate and act in conflicting ways for five to 10 years. Boards will have to make strategic bets on blockchain in a climate of uncertainty.

Risk management: Blockchain will increase risk in some areas, while decreasing it in others.

Increased risks:

■ It blurs the boundaries of previously well-defined entities, including sovereign states, industries, institutions and people.

■ The enterprise's reputation, information and systems become more dependent on a new technology that no one controls and whose full implications are not yet clear.

■ Enterprises will have to change their risk models to accommodate blockchain.

Decreased risks:

■ Blockchain offers transparent auditability and compliance.

■ It has no single point of failure.

■ It will support portable, secure and globalized identity.

Legal issues: Blockchain poses a number of big legal challenges:

■ Jurisdiction and enforcement are unclear for a distributed technology such as blockchain. For example, if fraud is suspected among people in various geographically dispersed locations using distributed systems, which law enforcement agency has the right to investigate, and how far afield can they go?

■ The legal basis for identity, trust, smart contracts, market standards, taxation and other components is undefined as yet, especially as the asset recorded in the ledger is a digital bearer instrument.

■ Frameworks and regulations such as know-your-customer laws that are the requirements to use specific market infrastructure and privacy laws, will have to be revised or substantially amended for blockchain.

■ Financial reporting requirements for companies using blockchain are unclear.

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■ Agreements governing product and service provision may have to be rewritten.

Recommendations ■ Propose that the board commission a scenario-planning exercise by engaging senior executives

to map out how the following three possible futures for blockchain will affect the enterprise's business (see "Use Scenario Planning to Make Business and IT Strategies More Resilient in an Increasingly Volatile World"):

■ The challenges of blockchain are resolved, and the democratization of value and development of distributed ecosystems proceed rapidly.

■ Governments and big companies reassert their power via regulation or control of key blockchain mechanisms. Development of the technology stops.

■ Incumbent businesses and processes melt down slowly, while disrupters offer some value at the fringes.

■ Encourage innovation by organizing visits to at least five blockchain startups related to your industry in the next six months, so you can more effectively update the board on cross-industry blockchain developments.

■ Ask the board to consider whether it needs to appoint new directors or new members of the executive committee with deep technology expertise.

■ Recommend that the board's risk committee investigate how blockchain will affect the enterprise's risk management strategy.

Gartner Recommended Reading Some documents may not be available as part of your current Gartner subscription.

"Survey Analysis: Boards' View of Digital Business Will Force CIOs Out of Their Comfort Zone"

"Defining Algorithmic Business"

"The Bitcoin Blockchain: The Magic and the Myths"

"Maverick* Research: The Programmable Economy Is the Ultimate Destination for Digital Business"

"The Future of Money Is the Programmable Economy, Not Just Bitcoin"

Evidence

We based this document on our study of blockchain startups, discussions with clients who are experimenting with or considering blockchain, and the thinking of the Gartner research community on the implications of blockchain.

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