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Preparing for a Blockchain Future

MICHAEL FERGUSON

Consider three key questions when determining how to make blockchain a useful part of your business strategy.

INNOVATION

Blockchain technology is set to be a major player of the future digital economy, but many business leaders remain unsure what that means for their companies going forward. In a Deloitte survey of 308 senior executives at large U.S. companies, 39% of respondents had little or no knowledge about blockchain technology. A survey of more than 200 board-level, non-IT executives in the U.K. yielded similar results: About 40% said they do not fully understand the technology, and less than 10% believe

their organizations have the necessary skill sets to adopt it.

To start by unpacking what blockchain really means, let’s refer to HubSpot’s approachable definition: Blockchain is “a record-keeping technology that is nearly impossible to tamper with. That’s because a blockchain’s records, or ‘ledger,’ is hosted by everyone in the network and openly available to everyone in the network, like a public spreadsheet that they add to but can never edit or delete.”

But where should business leaders go from there? How can they determine best practices for utilizing the decentralized web and make blockchain technology a useful part of their business strategy? My organization has found it useful to focus on the following three questions. These offer particular benefits for platform businesses, which will need to address weakening network effects as they lose ownership of participants’ data.

1. What value will we offer? This first question gets at the paradigm shift the decentralized web presents. The advent of blockchain isn’t just about new ways of operating. It forces many businesses — platforms in particular — to take a fresh look at why they exist.

INNOVATION

How Blockchain

Will Change Organizations

What if there were an internet of value — a secure platform, ledger, or database where buyers and sellers could store and exchange value without the need for traditional intermediaries? This is what blockchain technology will offer businesses.

Vol. 58, No. 2

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[OPINION]

How Blockchain Will Change Organizations

What if there were an internet of value — a secure platform, ledger, or database where buyers and sellers

could store and exchange value without the need for traditional intermediaries? This is what blockchain technology will offer businesses.

BY DON TAPSCOTT AND ALEX TAPSCOTT

or the last century, academics and business leaders have been shaping the practice of modern management. The main theories,

tenets, and behaviors have enabled managers to build corporations, which have largely been hierar- chical, insular, and vertically integrated. However, we believe that the technology underlying digital currencies such as bitcoin — technology com- monly known as blockchain — will have profound effects on the nature of companies: how they are funded and managed, how they create value, and how they perform basic functions such as market- ing, accounting, and incentivizing people. In some cases, software will eliminate the need for many management functions.

Sound far-fetched? Let us explain. The internet

vastly improved the flow of data within and be- tween organizations, but the effect on how we do business has been more limited. That’s because the internet was designed to move information — not value — from person to person. When you email a document, photograph, or audio file, for example, you aren’t sending the original — you’re sending a copy. Anyone can copy and change it. In many cases, it’s legal and advantageous to share copies.

By contrast, if you want to expedite a business transaction, emailing money directly to someone is not an option — not only because copying money is illegal but also because you can’t be 100% certain the recipient is the person he says he is. As a result, we use intermediaries to establish trust and maintain integrity. Banks, governments, and in some cases big technology compa- nies have the ability to confirm identities so that we can transfer assets; the intermediaries settle transactions and keep records.

For the most part, intermediaries do an adequate job, with some notable exceptions. One concern is that they use servers that are vulnerable to crashes, fraud, and hacks. Another is that they often charge fees — for example, to wire money overseas. They also monitor customer behavior and collect data, and they exclude the hundreds of millions of people who can’t qualify for a bank account. And sometimes, they make terrible mistakes, as the 2008 financial crisis made evident.

What would happen if there was an internet of value where parties to a transaction could store and exchange value without

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the need for traditional intermediaries? In a nutshell, that’s what blockchain technology offers. Value isn’t saved in a file somewhere; it’s represented by transactions recorded in a global spreadsheet or ledger, which leverages the resources of a large peer-to-peer network to verify and approve transactions. A blockchain has several advantages. First, it is distributed: It

runs on computers provided by volunteers around the world, so there is no central database to hack. Second, it is public: Anyone can view it at any time because it resides on the network. And third, it is encrypted: It uses heavy-duty encryption to maintain security.

Blockchain transactions are continuously verified, cleared, and stored by the network in digital blocks that are connected to preceding blocks, thereby creating a chain. Each block must refer to the preceding block to be valid. This structure permanently time-stamps and stores exchanges of value, preventing anyone from altering the ledger. To steal anything of value, a thief would have to rewrite its entire history on the blockchain. Collective self-interest ensures the blockchain’s safety and reliability. There- fore, we think blockchain provides a powerful mechanism for blowing traditional and centralized models, such as that of the corporation, to bits.

The Role of Transaction Costs

In a classic article published in 1937 titled “The Nature of the Firm,” economist Ronald H. Coase noted that there are costs associated with organizing production through the open mar- ket rather than through a firm — such as the cost of searching for relevant prices and the cost of negotiating numerous con- tracts. Coase expected businesses to expand internally until the cost of performing an additional transaction inside the organization become equal to the cost of using the open mar- ket. In a 1976 article, scholars Michael C. Jensen and William

H. Meckling added another dimension by introducing the concept of “agency costs,” which are the costs associated with managers’ tendencies to make decisions that are not optimal from an owner’s point of view.

Like many other analysts, we envisioned that the internet would reduce transaction costs so that corporate boundaries

would become more porous and organizations would seek talent outside their boundaries. As it turned out, the costs fell much further than we expected and in turn lowered barriers to entry for startups and established businesses looking to ex- pand into adjacent areas. To be sure, the internet reduced the costs of search, while email, social media, cloud computing, and applications such as enterprise resource planning reduced the costs of coordination. More broadly, these new capabilities

enabled corporations to outsource overhead, crowdsource inno- vation, and eliminate middle managers and other intermediaries, thus freeing industries such as accounting, commercial banking, and even music to consolidate assets and operations.

Managing With Blockchain

We believe that blockchain will transform how businesses are organized and managed. It allows companies to eliminate transaction costs and use resources on the outside as easily as resources on the inside. Vertical integration may continue to make sense in some situations (for manufacturing controlled pharmaceuticals, for example, or where companies have industry- leading strengths throughout the supply chain). But in most cases, we believe that networks based on blockchain will be bet- ter suited for creating products and services and for delivering value to stakeholders.

Human Resources and Procurement Blockchain will enable organizations requiring specialized talent and capabilities to ob- tain better information about potential contractors and partners than many traditional recruitment and procurement methods offer. With a prospective employee’s consent, an employer will have access to a cache of information that’s known to be correct because it has been uploaded, stored, and managed on a highly secure, distributable database. For example, job prospects wouldn’t be able to lie about their training or degrees because an authority, such as the university they graduated from, has entered the data on the blockchain. Tampering with data after the fact wouldn’t be possible: It would involve taking over the entire blockchain, a nearly impossible task. Individuals would control their own personal data (including birth date, citizenship,

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How Blockchain Will Change Organizations (Continued from page 11) financials, and educational records) in a virtual black box. They alone would be able to decide what to do with the information.

Human resources and procurement staff will need to learn how

to query the blockchain with specific yes or no questions — for example, Do you have this kind of license? Can you code in this specific language? The responses from all the black boxes will provide a list of people who meet these qualifications. Employers can ask whatever they want, and job seekers can program their black boxes with answers or refuse to answer.

Finance and Accounting Information about a business’s finan- cial well-being changes all the time. When you search the web for a company’s financial data, you search in two dimensions: horizontal (across the web) and vertical (within particular websites). What you find can be out-of-date or inaccurate in other ways. On a blockchain, though, there’s a third dimension: sequence. In addition to being able to obtain a historical picture of the company since it was incorporated, you can see what has occurred in the last few minutes. The opportunity to search a company’s complete record of value will have profound implica- tions for transparency as it brings to light off-book transactions and hidden accounts. People responsible for records and reports will be able to create filters that allow stakeholders to find what they are searching for at the press of a button. Companies will be able to create transaction ticker tapes and dashboards, some for internal use and some for the public. As extreme as this may sound, it’s really not.

Sales and Marketing Just as a blockchain provides a way to ob- tain information about potential contractors and partners, it will be able to tell you about people or businesses who are potential customers. As we have noted, individuals will control access to their own data in virtual black boxes, which will limit a compa- ny’s ability to profile customers by tracking and capturing their behavior online. However, the blockchain will allow companies to engage with individual customers on a peer-to-peer basis.

This may seem like a lot of effort, but it could actually be a huge opportunity. Some consumers may offer businesses access to

their data in exchange for freebies; others will charge fees to license their data. Either way, companies will be able to reach their target audience with greater precision.

What’s more, sellers won’t have to worry about who the customers are and whether they are able to pay. With the new platform, sellers won’t have to incur the cost of establishing trust — thus they can facilitate transactions that would have been risky or might not have been possible otherwise. Furthermore, blockchains will eliminate the cost of warehousing data and pro- tecting other people’s data from security breaches. It should also be easier to target customers who make their interests known.

Despite the advantages of being able to reduce risk, there is also a downside. The ability to make precise queries leads to pre- cise results. This means that there will be much less serendipity. With blockchains, you are less likely to discover people or part- ners who don’t fit your profile but are open to change, willing to adapt, and eager to learn.

Legal Affairs Coase and subsequent economic theorists have argued that corporations are vehicles for creating long-term contracts when short-term contracts require too much effort to negotiate and enforce. Blockchains facilitate contracting in both the short and long term. Through smart contracts — software that, in effect, mimics the logic of contracts with guaranteed exe- cution, enforcement, and payments — companies will be able to automate the terms of agreement. A contract can refer to data fields elsewhere on the blockchain (for example, a party’s account balance, a change in a commodity price, or an additional sale of a copyrighted work). It can trigger alerts and ensure payments.

Because the contracts will be self-enforcing, corporations will not want to enter into them lightly. Changing the terms of deals (or attempting to manipulate them) will be more challenging. Lawyers and other managers will need to learn how to audit legal templates and make sure the contract software supports what both parties agreed to do. They will also need to become knowledgeable on issues involving the blockchain and smart contracts. The fastest-growing specialty in the law firm of the future is likely to be “smart contract mediator.”

With the new platform, sellers won’t have to incur the cost of establishing trust — thus they can facilitate transactions that would have been risky or might not have been possible otherwise.

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Shareholders will be able to enforce the commitments executives make. Companies can specify relationships and state speciﬁc outcomes and goals so that everyone understands what the respective parties have signed up to do.

Raising Capital We believe blockchains will also transform the process of raising money. In our view, the blockchain has

the potential to disrupt the way the global financial system works and change the nature of investment. Mindful of this prospect, the New York Stock Exchange has invested in Coinbase Inc., a digital currency wallet and platform company headquartered

in San Francisco, California. For its part, the Nasdaq Stock Market is also experimenting with blockchain technology.

Integrating the Pieces

So how will blockchain help companies become stronger com- petitors? How can a company use it to integrate the various pieces? Blockchain technology provides a platform for people to work together with the persistence and stability of an organi-

zation but without the hierarchy. Consider ConsenSys, a venture production studio based in Brooklyn, New York, that builds de- centralized software applications and end-user tools that operate on blockchain. Founder Joseph Lubin describes the company’s structure as a hub-and-spoke arrangement rather than hierarchi- cal; each project operates on its own, with the major contributors holding equity. For the most part, people get to choose what they work on. The central hub provides supporting services to the spokes in exchange for a share of the ownership. The various rights and relationships are codified in smart contracts that

hold the entity together.

In recent years, we have been reminded all too often that managers don’t always act with the highest degree of integrity. (Think of the scandals at Enron, AIG, and Volkswagen, for instance.) What if we could codify ethics and integrity into the circuitry of the enterprise, or reduce the moral hazard that

too often sees management gambling with shareholder capital?

Through smart contracts under blockchain, shareholders will be able to enforce the commitments executives make.

Companies can specify relationships and state specific outcomes and goals so that everyone understands what the respective parties have signed up to do and whether those things are actually getting done.

On blockchain, executives will someday no longer need to

attest that their books are in order once a year or every quarter; the blockchain will keep a company’s books in order in what is, in effect, real time as a matter of course. Financial statements will go from snapshots of the enterprise at one point in time

to a transparent, three-dimensional view of the whole enterprise. Shareholders and regulatory agencies alike will be able to exam- ine the books whenever they choose. Institutional investors will have the ability to create their own credit dashboards based

on the facts, as opposed to relying on interpretations by ratings agencies. And ratings agencies themselves may overhaul their rating systems based on information from blockchains.

In contrast to the internet, which took two decades to develop and yet another decade to become commercial, the blockchain ecosystem is developing more rapidly as an economic platform. For executives, this means there is little time to waste. They will want to examine their industries and their competitors with an eye toward identifying opportunities for profitable growth.

Executives should begin by identifying people within the company who are interested in the technology or using digital currency. They should talk to people in the company’s IT depart- ment about the technology’s implications, buy some bitcoin,

and experiment with purchasing inexpensive items on the block- chain to see how it works. At the same time, they should identify nearby companies using blockchain — take the opportunity to visit their operations and talk with people involved, and invite experts to meet with the team. Now is the time to reimagine

how your company organizes the way it creates value. If you don’t, someone else will.

Don Tapscott is the chancellor of Trent University in Peterbor- ough, Ontario, and CEO of the Tapscott Group Inc. in Toronto. Alex Tapscott is founder and CEO of Northwest Passage Ventures, an advisory firm incubating early-stage blockchain companies,

in Toronto. They are the authors of Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business, and the World (Portfolio, 2016). Comment on this article at http://sloanreview.mit.edu/x/58222, or contact the authors at [email protected].

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Consider, for example, eBay, Uber, and Airbnb. Throughout the era of TCP/IP (the web protocol that computers use to talk to each other), these platforms have acted largely as centralized repositories of information.

You want to buy a product, they know who has it for sale. You need a ride, they know who can give you one. You need a place to stay, they know who has an extra bedroom to rent.

But as blockchains become more common, this kind of information will become publicly available and searchable. You won’t need a centralized authority to show you who has the waffle maker you’re looking for; you’ll be able to see a verified record of who is selling the waffle maker you want at a price you’re willing to pay and who has a track record demonstrating trustworthiness in such exchanges.

To stay relevant, companies will need to provide value in new ways. This requires creative thinking. In the case of my startup Rainmakers, our current business model focuses on placing sales professionals with leading technology companies. However, people will soon own and fully control the data that they now make available and view on our platform. Hiring managers will be able to find candidates with the right skills, experiences, and recommendations to meet their needs — without our help.

Read more free MIT SMR articles on the future of blockchain.

What Problems Will You Solve With Blockchain?

Blockchain Is Changing How Media and Entertainment Companies Compete

So, we’re investigating other ways to make hiring managers’ lives easier. These offerings include phone screening, validation of candidate data, and onboarding support. We’re also exploring how we might help candidates make themselves more attractive to employers. We’re rethinking our business model because blockchain could render the old one obsolete. This kind of strategic foresight and ability to sense and pivot will be crucial for organizations trying to compete in a blockchain-enabled world.

2. How public will our blockchains be? The next step is to decide whether to invite everyone into the blockchain network or create a more limited system just for verified participants. This, too, is a strategic question. It involves weighing the advantages and risks of an “open source” approach.

My team could end up doing both. For instance, we might build a public network where candidates can share much of the information that employers are looking for and also set up a private one with paid access to more granular data about individuals’ work experience and sales records. For everyone in the private blockchain — candidates and companies alike — all public and private information would be funneled through one integrated profile, simplifying the user experience.

Having a robust and growing public blockchain would draw all the right players to our business, including job seekers, hiring managers, and other staffing companies. And the bigger our public blockchain becomes, we’re betting, the more companies will want to pay for access to the private one.

3. What incentives will we offer to participate? We recognize that we won’t suddenly have millions of

individual job seekers and stafng companies creating profles on our blockchain. We’ll need to draw them in by frst attracting a critical mass of hiring companies to the platform early on — which means providing immediate value to those partners.

Even if the number of candidates on our private blockchain is small at frst, we’ll be working to gather information from them that isn’t available elsewhere — this kind of information will help companies make the right hires, as we’ve seen over the years placing salespeople into different organizations. Likewise, other businesses could follow a similar model, capitalizing on their expertise in their respective industries while moving to a blockchain strategy.

For example, businesses might offer crypto tokens, or blockchain assets, as additional incentives for participation. (For a helpful primer on tokens, see “Some Simple Economics of the Blockchain,” a working paper by Christian Catalini of MIT Sloan School of Management and Joshua Gans of the Rotman School of Management.) We’re considering how we might use tokens as incentives at Rainmakers. We could allow job candidates to earn them for keeping their résumés updated, for example, and cash them in for enhanced visibility on our platform, the chance to apply for certain positions, or services such as

training and assessment. Employers who use our site could earn them by validating employees’ data and spend them on vetting and onboarding services. We could allow third parties to provide services on our platform and earn tokens, as well.

To Innovate, Be Willing to Evolve

Of course, our strategy will most likely evolve as we see how blockchain technology is adopted in our industry and as our own implementation presents new challenges and opportunities. That will be the case for every business. It’s important to revisit these three questions and continually assess and adjust the business model.

Blockchain and the decentralized web aren’t just hype. They’re what lie ahead. According to the Deloitte survey, 21% of senior executives who are informed about blockchain indicated that their company has already brought the technology into production, while 25% plan to do so within the next year.

Businesses that don’t sort out their blockchain strategy soon risk being disrupted by competitors and, worse, watching their entire business models go obsolete.