Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

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Fri, 20 Jan 2017

The blockchain as an ERP for a whole industry

In the eight years since Satoshi Nakomoto created Bitcoin, there has been a lot of interest in applying the underlying technology, the blockchain, to other problems in finance. The blockchain or the Distributed Ledger Technology (DLT) as it is often called brings benefits like Byzantine fault tolerance, disintermediation of trusted third parties and resilience to cyber threats.

Gradually, however, the technology has moved from the geeks to the suits. In the crypto-currency world itself, this evolution is evident: Bitcoin was and is highly geek heavy; Etherium is an (unstable?) balance of geeks and suits; Ripple is quite suit heavy. History suggests that the suits will ultimately succeed in repurposing any technology to serve establishment needs however anarchist its its original goals might have been. One establishment need that the blockchain can serve very well is the growing need for an industry-wide ERP.

ERP (enterprise resource planning) software tries to integrate the management of all major business processes in an enterprise. At its core is a common database that provides a single version of the truth in real time throughout the organization cutting across departmental boundaries. The ERP system uses a DBMS (database management system) to manage this single version of the truth. The blockchain is very similar: it is a real time common database that provides a single version of the truth to all participants in an industry cutting across organizational boundaries.

To understand why and how the blockchain may gain adoption, it is therefore useful to understand why many large organizations end up adopting an ERP system despite its high cost and complexity. The ERP typically replaces a bunch of much cheaper department level software, and my guess is that an ERP deployment would struggle to meet a ROI (return on investment) criterion because of its huge investment of effort, money and top management time. The logical question is why not harmonize the pre-existing pieces of software instead? For example, if marketing is using an invoicing software and accounting needs this data to account for the sales, all that is really needed is for the accounting software to accept data from the marketing software and use it. The reason this solution does not work boils down to organizational politics. In the first place, the accounting and marketing departments do not typically trust each other. Second, marketing would insist on providing the data in their preferred format and argue that accounting can surely read this and convert it into their internal format. Accounting would of course argue that marketing should instead give the data in the accountant’s preferred format which is so obviously superior. Faced with the task of arbitrating between them, the natural response of top management is to adopt a “plague on both houses” solution and ask both departments to scrap their existing software and adopt a new ERP system.

It is easy to see this dynamic playing out with the blockchain as well. There is a need for a single version of the truth across all organizations involved in many complex processes. Clearly, organizations do not trust each other and no organization would like to accept the formats, standards and processes of another organization. It is a lot easier for everybody to adopt a neutral solution like the blockchain.

A key insight from this analysis is that for widespread adoption of blockchain to happen, it is not at all necessary that the blockchain be cheaper, faster or more efficient. It will not be subjected to an ROI test, but will be justified on strategic grounds like resilience to cyber threats and Byzantine actors.

The only thing that worries me is that the suits are now increasingly in charge, and cryptography is genuinely hard. As Arnold Kling says: “Suits with low geek quotients are dangerous”.

Posted at 17:34 on Fri, 20 Jan 2017     View/Post Comments (0)     permanent link