IBM’s 5 megabyte hard drive being shipped out (1956)

Blockchain, blockchain, blockchain. We’ve gone through the cycle of hyperbole and we have heard promises that this technology is about to change everything!

Yet, we still haven’t seen any killer applications go live from any of the incumbents that are singing its praise. For the time being, there is still a lot of noise with salespeople holding meetings, throwing conferences, and making press releases about half-baked proof of concepts. It seems like the only ones making money of the blockchain in the corporate world are the consultants.

If blockchain is so great, then why does it seem so hard to start ‘blockchaining’? Is it really all hype? Will we never see this blockchain revolution we’ve been promised?

Let’s take a step back and talk about two important concepts: ‘disruptive innovation’ and ‘sustaining innovation’. This will offer some clarity on the current state of the blockchain space, allowing us to see it from two different perspectives and cut through the hype.

Disruptive vs sustaining

Harvard professor, Clayton Christension, has written a lot about disruptive innovations. He has argued that this term is being used too broadly and even suggested that, strictly speaking, Uber is not a ‘disruptive innovation’.

He defines disruptive innovation as:

“An innovation that is disruptive allows a whole new population of consumers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill.”

And sustaining innovation as:

“making good products better in the eyes of an incumbent’s existing customers”

“Companies pursue… sustaining innovations at the higher tiers of their markets because this is what has historically helped them succeed: by charging the highest prices to their most demanding and sophisticated customers at the top of the market, companies will achieve the greatest profitability.”

The grassroots blockchain market

Now, let’s take a brief walk through time as we think through these two concepts.

Bitcoin is where it all began. A technology that allowed individuals to send peer-to-peer transactions. To move value from point A to point B without relying on any financial institutions that have, until now, held a monopoly over the control and the movement of people’s value.

We then saw a flurry of excited traders keen to start making bets on this new speculative asset class.

Then entered Ethereum. A far more ambitious protocol redesigned from the ground up to enabled peer-to-peer financial agreements. This capability dug deeper into the financial industry’s underlying business models, posing a direct and existential threat.

Since then, we have seen the growth of some truly disruptive practices and applications.

The first examples include decentralized applications built on the Ethereum network. Each project is at different stages of development but, they have some fascinating implications — prediction markets, crypto-mutual funds, commodity asset-tokenization, decentralized exchanges, decentralized supercomputer services. We will go into further detail as to why exactly these are disruptive innovations a little later on.

One of the incredible attributes of these projects is how they are funding their ambitions; a new phenomenon called the initial coin offering (ICO). This was pioneered by the Ethereum project when it raised around $18 million dollars to fund the development of the current Ethereum protocol.

Instead of having to go through the traditional VC song and dance, ICO startups raise funds by appealing directly to the Ethereum community. In return, investors receive tokens that should increase in value if the on-chain product becomes a success. These tokens are often integral to using the product and can even represent dividend bearing tokens that will earn an income from the project. Just this month, Golem, a decentralized supercomputer service (think of a distributed AWS), raised $8 million in just 23 minutes.

A third example that nicely demonstrates the disruptive capabilities of this new technology was seen after an exchange, Bitfinex, was hacked and lost 119,756 BTC (almost $90 million at current valuation). Instead of going through the bankruptcy courts and closing up shop, Bitfinex imposed a 36% haircut on users’ account balances and in return they received a tradable debt token. This is essentially an IOU from Bitfinex to reimburse them for their losses. Users were also given the option of exchanging their token for an equity stake in Bitfinex. Alternatively, users can sell their token and recuperate some of their losses since a market for the token quickly formed after their creation and distribution.

This was obviously not an ideal scenario for their users, but, it’s interesting in that we saw an example of how this financial technology can be leveraged in a novel way. Bitfinex was able to quickly and cheaply create and distribute a financial instrument resembling a corporate bond/security without having to go through a traditional financial institution. Instead of going bust and walking away, Bitfinix is trying to make their users whole again by leveraging this new technology.

Truly disruptive applications

I think professor Christension would agree that these phenomena fit his definition of disruptive innovation quite nicely.

One of Bitcoin’s first use case was speculation. Consumers at the bottom of a market started trading this new asset class through niche exchanges. It only costs pennies to enter into a trade versus the tens or sometimes hundreds of dollars charged by traditional brokers. This provided greater access to individuals, some of whom may have never participated in traditional capital markets, to start making bets at a lower cost.

With Ethereum, organizations are able to execute peer-to-peer financial agreements allowing them to issue their own corporate tokens to pay off a debt or issue token assets to raise money for a project. Traditionally, such products were only made possible through the financial industry, which largely caters to sophisticated “consumers with a lot of money or a lot of skill.” For a firm to IPO is a lengthy and capital intensive process with underwriter fees alone costing an average of $3.7 million dollars.

Decentralized applications are introducing financial services that live entirely outside of the traditional system. Prediction markets like Augur and Gnosis will allow users to start making bets on much more than just the price of Ethereum and other cryptocurrencies. These platforms aim to let their users make bets on almost anything with a clear outcome — the weather, political elections, sports, and even events in capital markets. Crypto-mutual funds, namely ICONOMI, aim to introduce both passive and active investment funds where users can create portfolios with exposure to the larger crypto-market.

Blockchain technologies are facilitating an emerging group of consumers able to use cheaper and more accessible financial products. Startups are able to offer services that sophisticated VCs, banks, brokers, and stock exchanges have traditionally only been able to facilitate.

Barbarians at the gate

To the incumbents, watching this all unfold must be scary. At least it should be. Its no surprise that a swath of technology companies and financial institutions are pushing mandates to their innovation teams to start ‘blockchaining’.

But, it has never been easy for a large enterprise to innovate, as Christension has famously described in his book ‘The Innovator’s Dilemma’. Incumbents will innately go after sustaining innovations to improve their established product to better serve their existing and most profitable customers.

Incumbents know this and see blockchain technologies as a threat but, also as an opportunity. It could legitimately improve the functionings of our entire financial system. It could lower costs, introduce greater transparency, and reduce risk in capital markets.

However, that journey won’t be easy and it won’t be pretty. Replacing legacy systems is a huge challenge. Bitcoin and Ethereum were not designed to be sustaining innovations, nor are they compatible with existing regulatory paradigms. It’s logical for incumbents to develop corporate-friendly blockchains like Hyperledger or approach this technology through commercial consortia like R3CEV.

The question is, whether this strategy will keep them ahead of the wave of disruptive applications being developed on top of these open protocols, namely Ethereum. These decentralized applications are targeting an ever growing market of consumers that have largely been ignored by the financial system.

In truth, these decentralized applications have yet to penetrate a wider audience, it is still the playground of hackers, cypherpunks and traders. But, if you look at the social, economic and political turmoil happening in India over the past few weeks, and you consider the financial exclusion and uncertainty that billion of people face every day, you realize that there is a serious demand. Protocols like Ethereum are solutions to fill that demand.

For now, most incumbents will approach blockchain technologies as a sustaining innovation. This will allow them to explore the technology and adopt some important capabilities. Time will tell if this will lead to the development of any ‘disruptive’ corporate applications that conform to Christension’s definition. Otherwise, as this market continues to mature and the technology becomes more sophisticated, incumbents will be facing a new generation of crypto-users and a lost opportunity.