Understanding the Basics of Blockchain: Cryptocurrency, NFTs, and Digital Disruption

In this article by Dr. Hubert Pun, Professor of Management Science at the Ivey Business School, we look at Blockchain technology, how it’s currently being applied to business operations, and consider how this technology could impact and disrupt the future of business. Dr. Pun is also featured on a recent Ivey Academy podcast episode on the topic of Blockchain Technology in Business.

Introduction

Being a leader demands thinking ahead, especially when it comes to technology. The consequences of ignoring potential digital disruption in almost any organization or industry can be severe, as shown by firms like Blockbuster (pushed out of the market by Netflix’s online subscription model) and Barnes & Noble (in-store sales threatened by Amazon’s online retailing). In contrast, investing in emerging technologies before they become entrenched may offer huge advantages. One such technology that leaders can’t afford to ignore is blockchain. 

What is Blockchain? 

Simply put, blockchain is a chain of “block.” A block can be a video, a photo, or any other type of content. The first person in a blockchain creates a block; when the second person creates a block, this block includes a reference that points to the first block. Someone else then creates the third block, which includes a reference that points to the second block. In this way, it becomes a chain of blocks, also referred to as a “database.” See here for a further explanation of how blocks are added to a blockchain.

Two important features of blockchain are that it is distributed and decentralized. A traditional database, which lacks those qualities, is known as a centralized database. For example, when a professor records all student grades in one database, that is a centralized database; the professor is the only person with a copy of the database and the only person who can make changes to it. Students trust the integrity of this database because they trust its centralized figure (the professor). Conversely, without a trustworthy centralized figure, the record itself becomes untrustworthy. 

Blockchain eliminates the need for a trustworthy centralized figure. Since it is distributed, there are multiple copies of the same database. Since it is decentralized, different people on the blockchain network can make changes to this database, which will then be propagated to all other databases. When there is inconsistency among different copies, majority rules, making it extremely difficult for anyone to alter the blockchain. The end result is an immutable and trustworthy database. 

Blockchain in Action 

The most famous example of blockchain application is Bitcoin. Bitcoin offers unique advantages as a new alternative to traditional payment methods, such as credit cards. For instance, when you make a purchase using your credit card, the transaction is recorded in the bank's database. This is a centralized database; you trust its integrity because you trust the bank as a centralized figure. But Bitcoin – via its underlying mechanism of blockchain – eliminates the need for a centralized figure. Everyone on the network owns a copy of the database. At the same time, every Bitcoin transaction is pseudonymous (i.e., the identifier is the Bitcoin address, which differs from an individual's actual name). The database is also encrypted, further protecting users’ identities. With so many people having a copy of this database, it is virtually impossible to make any changes without other people realizing. Hence, users can trust the integrity of the Bitcoin database. 

Another way blockchain can be applied is to improve supply chain traceability. For example, Walmart currently uses blockchain for food traceability, connecting suppliers, shippers, and buyers so customers know exactly where their food is coming from. Similarly, Starbucks, in partnership with Microsoft, now uses blockchain so that customers and farmers can ensure that their coffee is ethically produced. In the diamond industry, De Beers is using blockchain to demonstrate the origins of its diamonds and reduce trade in “blood diamonds” (i.e. diamonds sourced from war zones and sold to finance conflicts).

Blockchain can also be used to encourage eco-friendly consumption. BYD, an electrical vehicle company in China, has set up an ecosystem composed of environmentally friendly firms from different industries. Within this ecosystem, customers can collect and redeem points which encourage more consumption within the green environment.

However, other blockchain-based initiatives have not been so successful. When Maersk and IBM created the blockchain-powered TradeLens platform to encourage digitization of global trade in the shipping industry, it seemed like a promising endeavor. However, the initiative was discontinued in November 2022, partly because the founders couldn’t get the critical mass needed to sustain the platform. 

Still, the use of blockchain continues to spread and advance quickly, particularly in the form of non-fungible tokens. 

Non-Fungible Tokens (NFTs) 

Non-Fungible Tokens (more well known by their acronym, NFTs) are digital assets that are created on a blockchain network with unique identification codes that distinguish them from each other. Their digital and non-fungible nature can best be understood by looking at the 2x2 table of assets below. “Fungible” means that the token is interchangeable. For example, cash is a fungible asset because a $10 bill has the same value as two $5 bills. On the digital side, Air Miles points are fungible because all Air Miles points are the same. “Non-fungible” means that the assets are unique and different within their same asset class. For instance, my passport and your passport are both passports, yet each is completely unique and non-interchangeable. A digital example of a non-fungible asset would be one player’s video game “skin”, or character appearance, versus another’s. 

NFTs are non-fungible, or unique, digital assets that turn information – such as “Jack Dorsey’s First Tweet”  – into assets that can be bought and sold.  

NFTs are already impacting many diverse industries. In the art industry, they are being used to bridge the gap between artists and end consumers, ensuring that artists receive fairer compensation for their creations. NFTs are also being used in the fashion industry. For example, Nike recently bought an entirely virtual shoe company that makes NFT sneakers “for the metaverse”. H&M launched its first virtual fashion collection. Luxury brands like Gucci and Louis Vuitton are similarly investing extensively in NFTs.  

Likewise, the sports industry is producing NFT collectibles. Whereas collectors could previously acquire, for instance, a physical basketball card that shows Michael Jordan slam-dunking, now they can purchase an NBA Top Shot digital collectible and “own” the moment when LeBron James slam-dunks to win a game.

Controversies in Blockchain 

Blockchain can be a double-edged sword. On one hand, it offers many benefits that a traditional structure cannot —  for example speed, convenience, and removing the need for a centralized figure. However, the blockchain market is largely unregulated, so it is currently a Wild West. For example, insufficient regulation led to the collapse of cryptocurrency exchange FTX, which resulted in millions of losses to funds such as the Ontario Teachers' Pension Plan and individuals like NFL player Tom Brady. Moreover, blockchain platforms vary in their implementation of Know Your Customer (KYC) requirements, so criminals can buy cryptocurrency or NFTs from a platform with minimal KYC, and then resell them to another platform with tighter KYC to launder illicit funds. There are also multiple wash-trading instances where bad actors buy NFTs at a low price, and then set up multiple fake account to transact the NFTs at higher prices.

Looking Forward 

The evolution of the Internet offers hints about how blockchain may evolve. The Internet was started in the 1970s with the purpose of doing things cheaper and faster. Thus, the early business applications of this technology were in industries that needed to be cheaper and faster (e.g. email offered a cheaper and faster substitute to a comparable business, physical mail). Yet, after more than 40 years of development, the latest business applications of Internet technology are transformational – they do not have any comparable business outside the Internet. For example, rather than selling traditional products, Internet giants like Google or Facebook now sell information about and attention from their users to advertisers — a business model would have been unimaginable prior to the Internet. 

Blockchain will likely follow the same pattern. We are still at the early stage where blockchain technology is being used to substitute existing business (e.g. Bitcoin payments substitute traditional banking). However, there will undoubtedly be some transformational future applications of blockchain that we can’t even imagine yet. 

For this reason, leaders need to think not just about current challenges and developments, but about what their industry could look like 5 or 10 years from now. Blockchain is still a relatively new technology. Investing in it now would be a high-risk, high-reward decision. That said, the technology is mature enough that many established brands, like those mentioned above, are already capitalizing on it. Companies that wait for this technology to stabilize risk becoming followers (low risk, low reward) or, worse, becoming irrelevant.  

Q&A

We recently hosted a livestream on this topic (you can listen to a podcast episode from this event here), and our viewers submitted a range of questions in the chat that will help demystify some of the frequently asked questions about Blockchain. Here is a Q&A breakdown of the most common questions: 

Trust, Privacy, and Authenticity 

Q: What is stopping individuals from entering fraudulent information? “If someone wanted to move blood diamonds, what would stop them from fraudulently representing their diamonds entering a supply chain as coming from an ethical source?” Further, how can the chain maintain integrity if an error/fraudulent block is added? 

A:  Blockchain cannot prevent someone from entering incorrect information. One way to minimize careless manual data entry error is to pair up the use of blockchain with Internet of Things (IoT) to automate the data entry process. Click here to see some examples. 

A related comment: When someone attempts to change information (e.g., if someone tries to enter an error/fraudulent block), this changed information cannot achieve consensus with everyone else’s database. Therefore, incorrect information would not be preserved in the blockchain. See this article about how to reach a consensus.

Q: If everyone can see my transactions, how can I protect my privacy? If I can do transactions anonymously, how can others verify the authenticity of the transactions? 

A The transaction that is used to achieve consensus is in an encrypted format. Therefore, only people with the key to the encryption can read the message. 

Q: Is there a way to evaluate the value of a digital asset? 

A: This is the same as how any other type of asset is priced (e.g., stock price, real estate, etc.) : this is based on supply-and-demand. 

Administration and Regulation 

Q: It seems that most of the expansion and growth of blockchain technology  has been driven by the private sector – How could governments adopt it for their citizens? How can SMEs be integrated into this new economy driven by blockchain?” 

A:  There are many ways that this technology could apply to the public sector. A possible application is digital identity. For example, let’s say I check-in at a hotel and the staff asks for a photo ID. They only need to know that the photo ID is legitimate; they do not need to know my home address or my birthday. A blockchain-powered digital ID allows an individual to decide what information to share (or not to share). 

Possible SME business integration: Not all industries will experience blockchain equally. The early applications are in the financial services sector. Another early adopter is the supply chain industry where traceability is needed. Please take a look at the main writing for examples (e.g. Walmart, Starbucks, De Beers, and BYD). 

Q: What are your thoughts on responsible governance/policy in a deregulated setting such as blockchain when it comes to issues like asset washing (e.g. NFT washing)? Is there a body that currently does/will in the future regulate and set the standards of how blockchain is used? 

A: Government regulation always lags technology adoption.  The level of regulation must be in the sweet spot: too many regulations would kill an emerging technology; too loose, then people will take advantage of that (e.g. the recent FTX collapse problem). Currently, governments are still listening to leading companies about how to best regulate blockchain. Cryptocurrency is harder than most other emerging technologies to regulate because of its decentralized nature. Lastly, we expect there will be a set of new governance bodies to set the blockchain standard. 

Q: What is the infrastructure of the core blockchain servers? How do servers communicate with each other? Is the widespread use of blockchain technology limited by the number of servers available? 

A: Due to the decentralized nature, there is no “core blockchain servers”. Information is stored on the cloud in a decentralized fashion. For Bitcoin mining, then there are server farms; here are examples of mining hardware machines.

The nodes use consensus protocol to communicate with one another to verify that information is accurate. See here for more detail.

Blockchain is not limited by the number of servers. Rather, just like any other computer network, it is limited by capacity and efficiency. For example, for a busy blockchain network, more computation powers (e.g., faster chips) are required to make sure that the network is running smoothly. 

Adoption & Disruption 

Q: How can an individual invest in this technology? 

A: Knowing the technology (what it can and cannot do) would be an important first step. In terms of personal investment opportunity, beginners can start with well-known cryptocurrencies such as Bitcoinor Ethereum. Other investment possibilities are NFT arts, digital collectibles, and digital land. 

Q: Why has Blockchain taken so long to be embraced more widely by the business community / by society as a whole? General interest in how this technology can be applied in different industries – want case examples. Also interested in how they can adopt it into their own business operations. 

A: Blockchain is still in the early stage. This is like the internet in the mid 1990s (dial-up internet access with a 14.4k modem). Killer apps have not yet been invented. 

See the previous response and the main writing for some existing applications. 

Q: In your opinion, is the fundamental business model for banks at risk? What are the implications of an increase in Decentralized Finance (DeFi)? 

 A: Blockchain generates new banking needs; some examples are decentralized finance (DeFi), and currency in a digital format, such as Central Bank Digital Currency or cryptocurrency like Bitcoin.  Either a new type of bank will emerge to address these needs, or the existing banks will expand their services to cover these needs. 

Q: Blockchain could disrupt the model of people ‘selling’ their personal information to vendors; what are the implications to social media platforms, as an example, since blockchain seems like it has the potential to upend the ‘people is the product’ model? 

A: Currently technology firms (e.g., Google and Facebook) are making money with our personal information. “Web 3.0 is focused on making personal information private again. It builds on a growing movement to give users control over their data ownership and monetization” (Forbes). For this ideology to thrive, businesses must come up with a way to make money by “giving users control over their data."

This article is authored by Dr. Hubert Pun, Associate Professor of Management Science at the Ivey Business School.  His research interests include co-opetition, counterfeiting product, and how blockchain can be used as an enterprise solution, and he has received the Western Faculty Scholar Award for his research contribution to blockchain business application.

Additional Resources:

A Look Back At Why Blockbuster Really Failed And Why It Didn't Have To (Forbes)
How Barnes & Noble, the last big bookstore, fell to Amazon (Axios)
How Blocks Are Added to a Blockchain, Explained Simply (CoinDesk)
Blockchain in the food supply chain - What does the future look like? (Walmart Global Tech India)
Starbucks Customers, Farmers Can Now Trace Their Coffee With Blockchain (SupplyChainBrain)
How Blockchain Could End The Trade In Blood Diamonds - An Incredible Use Case Everyone Should Read (Forbes)
BYD: Blockchain-Enabled Green Ecosystem (Ivey Publishing)
Tradelens Discontinues Operations. Why You Should Care (Forbes)
'Jack Dorsey's First Tweet' NFT Went on Sale for $48M. It Ended With a Top Bid of Just $280 (CoinDesk)
Nike just bought a virtual show company that makes NFTs and sneakers 'for the metaverse' (The Verge)
A virtual reality at H&M Group (H&M)
Gucci goes deeper into the metaverse for next NFT project (Vogue Business)
Louis Vuitton to release new NFTs (Vogue Business)
NBA Topshot - Next Generation Collectibles
The Collapse of FTX: What Went Wrong With the Crypto Exchange? (Investopedia)
Who are the big names affected by the FTX crash? Tom Brady, Ontario's Teacher Pension Plan. Steph Curry and more (The Globe and Mail)
Cryptocurrencies: Tracing the Evolution of Criminal Finances (Europol Spotlight)
Over $30B of NFT Trading Volume on Ethereum Is Wash Trading, Research Suggests (CoinDesk)
Blockchain and IoT: 10 Examples Making Our Future Smarter (BuiltIn)
How does blockchain solve the Byzantine general's problem? (CoinTelegraph)
How Blockchain Can Transform the Financial Services Industry (U.S. News - Money)
The 10 Best Bitcoin Mining Hardware Machines 2023 (CoinLedger)
NFTs Can Be Artistically Groundbreaking Meet the Artists and Curators Leading The Way (ARTnews)
Investing in Digital Collectibles (The Motley Fool)
Why is Digital Land Valuable, and How Does One Buy It? (Real Vision)
Central bank digital currency (CBDC) (Bank of Canada)
In Web 3.0, Data Ownership And Monetization Must Belong To Individuals (Forbes)

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