3

Understanding the Technology Landscape

Open technology architecture, economic viability, and longevity of the blockchain network should be some of the primary design criteria.

—Nitin Gaur

Blockchain has tremendous potential and is much more than the sum of its core components. Enterprise blockchain provides a design avenue in which transaction data, value, and state are inherently close to the business logic, and the security of the execution of business transactions is validated by a secure community process, enabling a foundation of trust and the robust processing of transactions. There are certainly virtues to using a blockchain as a technology alternative that is permissioned and conforms to all the regulatory platforms that have evolved over time. Indeed, blockchain promises to solve long-standing industry concerns, such as modernizing the financial and trade system and speeding up securities and trade settlements. The goal is meaningful application of technology to move goods and money seamlessly with full systemic transparency, trust, and accountability of participants, all without an intermediary, and faster and at much lower cost.

Blockchain: A Technical Perspective

As described in Chapter 2, blockchain technologies are viewed as a disruptive force for existing industries such as healthcare, supply chains, trade logistics, financial systems, and market infrastructure, and promise to fundamentally change the way that these industries operate. Nevertheless, some thorny challenges related to enterprise adoption must be addressed before you can adopt blockchain:

  • Blockchain currently lacks generally accepted definitions and standards. Standards bodies and ISO (International Organization for Standardization) initiatives, such as TC307, are currently attempting to standardize the taxonomy, terminology, and other standards for blockchain. Such standards are essential to widespread adoption of blockchain.

  • To use blockchain in their production systems, industries must address the enterprise challenges of transaction audibility, visibility, and integration into existing business functions.

  • Blockchain is a cryptographic database technology that was popularized by its association with cybercurrency (for example, Bitcoin and Altcoin). However, the technology itself has the potential to change the world. Blockchain technology solves the issue of time and trust, and provides a platform to eliminate middlemen (disintermediation) regardless of the industry.

  • Blockchain-backed business models are emerging that aim to change how industries operate by using co-creation schemes and changing the dynamic of ecosystems. These business models, which are based on digital trust, digital assets, digital (trust) equity, cross-ledger and cross-network transactions, and digital identity, aim to establish blockchain-powered business networks that are trusted and secure, facilitating a new type of interaction that can lead to new business models.

The Four Building Blocks

At a basic level, any proposed blockchain solution includes four building blocks: (1) a distributed (or shared) ledger; (2) cryptographic protocols; (3) consensus vehicles (trust system); and (4) chaincode, smart contracts, and business rules (Figure 3.1). These four building blocks collectively form the blockchain technology components, and they have independently existed for decades. Except for evolutionary changes in each of these technology domains, their core principles are understood and accepted.

An illustration shows the four building blocks of the blockchain.
Figure 3.1 The building blocks of blockchain.
Distributed (or Shared) Ledger

Distributed ledgers maintain the record of asset ownership. They are essential to achieve transactional finality. They ensure that the distributed transaction record cannot be changed, and they accept only appended records. Although the intended design of public or permissionless blockchain is to ensure visibility, an enterprise blockchain must account for regulations regarding the privacy of consumer data, and the exposure of business information to competitors.

Cryptographic Protocols

“Cryptography is about constructing and analyzing protocols that prevent third parties or the public from reading private messages.”1 Cryptography enables various systemic attributes of blockchain security, such as transport security, hashing functions, and data and packet encryption. Cryptography also ensures authentication and verifiable transactions.

Cryptography focuses on computational hardness to make cryptography more difficult to break by any adversarial process in the distributed system. Cryptographic protocols work with the consensus or trust systems of a blockchain network. The cryptographic considerations change when they are used in a permissioned ledger network.

Consensus Vehicles (Trust System)

Consensus is essentially a group decision-making process that aids in achieving transaction finality. It is the core of blockchain-powered networks, and it works with the other three components to ensure that the network agrees on the transfer of an asset or a change in the distributed ledger. In general, trust system is the preferred term for this component, because not all validation is done through the consensus system.

This foundational element dictates the overall design of and investment in a blockchain infrastructure. Many new and innovative approaches to the trust system in the blockchain space have been proposed, with these variants offering specialization for specific use cases. It is the trust model that makes blockchains effective and delivers the staples of blockchain technology—namely, trust, security, transactionality, trade, and ownership. The trust system is the primary driver of the transaction system that blockchains replace. If only trade and ownership were addressed by distributed or shared ledgers, then the plurality might be addressed with an array of database solutions.

Consensus systems directly impact computational costs and the investment required for blockchain-based systems, so you must account for this cost when you are doing system design. Acceptable consensus models are emerging that provide value generation capability to the blockchain-powered networks.

Chaincode, Smart Contracts, and Business Rules

Smart contracts, also known as chaincode, are essentially codified business rules that govern the movement of assets between participants in a network. Chaincode aids in verification validation, and it provides the consensus mechanism that is used for transaction finality.

Blockchains can run code. Although the first blockchains were designed to perform a small set of simple operations (transactions of a digital asset-like token), techniques have since been developed to enable blockchains to perform more complex operations that are defined in full-fledged programming languages. Because these programs are run on a blockchain, they have unique characteristics compared to other types of software, such as business terms that are embedded in a transaction database and run by transactions. This kind of rules component is needed by any business to define the flow of the value and state of a transaction.

Why Blockchain?

So why blockchain? And why now? What makes this technology so special that it has attracted massive investment and forced the likes of supply chains, trade logistics, and the finance industry to rethink their business models under the guise of disruption? The answer likely lies in the Bitcoin blockchain system, which possibly is the only initial functional evidence of a peer-to-peer permissionless network. Although the Bitcoin blockchain system cannot be directly adopted into an enterprise model, much can be learned from it and then applied to a successful blockchain for enterprise.

Bitcoin has gained notoriety for being a radical and unregulated rogue (cyber) currency—a reputation that has prompted some regulated entities to distance themselves from the concept. However, many businesses see the virtues of using blockchain as a technology alternative that is permissioned and conforms to all the regulatory platforms that have evolved over time. Such an approach holds promise as a means to solve long-standing industry concerns, such as modernizing the financial and trade system and speeding up securities and trade settlement. The goal is meaningful application of technology to move goods and money seamlessly with full systemic transparency, trust, and accountability of participants, all without an intermediary, at a faster pace and a much lower cost.

Although the blockchain industry sees a clear separation between the enterprise world and the crypto world, we see a disconnect in understanding the technology trust system that makes a blockchain so attractive. The tenets of Bitcoin are driven by economic incentive (a rewards system for upkeep, longevity, high availability, and system maintenance), cryptography (to ensure order in a chaotic and permissionless world), and specialized computational power (massive clusters and hardware that are dedicated to solutions for bitcoins). Bitcoins signify that a trust currency can be either earned or bought, essentially representing the value of the invested economic resources (people, power, and time). When we apply these tenets to a permissioned ledger and network, the radicalized trust currency must be morphed into a viable trust system that you can choose to ignore or adopt as a foundation for incentive economics that are based on the trust system or consensus models.

Many consensus models, such as Byzantine Fault Tolerant (BFT) or Practical Byzantine Fault Tolerant (pBFT), RAFT, and Paxos, can address all use cases. An enterprise must understand them and drive investment into the underlying resources—that is, talent, energy, and time.

Resource considerations are important for any enterprise venturing into the realm of blockchain. This is another principle from the Bitcoin blockchain world, which is now dominated by specialized hardware, which in turn adds to the growing resource requirements. A data structure (a shared ledger), cryptography, encryption, and high I/O (input/output) (due to shared ledger replication, consensus, and other network group services) collectively place extraordinary demands on underlying resources.

Blockchain as a Consumable Technology

So, what else does an enterprise need to consider to make blockchain a consumable technology? Here are some considerations:

  1. Enterprise integration:

    1. Integration with the incumbent system of record (SoR): The solution must support existing and incumbent systems, such as customer-relationship management (CRM), business intelligence, and reporting and analytics. This integration is also important because the investments that are made in these systems are significant and embedded into various operational elements of a business.

    2. The blockchain as a transaction processing system: The SoR may be preserved as an interim approach to adopt blockchain, but an enterprise cannot have two systems as a transaction processing system—that is, a transaction cannot be processed twice.

    3. Design intent to include: The path of least disruption accelerates the enterprise adoption. This is a vital consideration due to costs and the disruption of operations.

  2. Auditing and logging: Auditing and logging address enterprise technology preferred practices, such as change management, support, and high-availability disaster recovery (HADR) requirements, as well as enterprise business practices and reporting requirements. You must satisfy regulations regarding regulated systems for purposes of nonrepudiation, technology root-cause analysis, fraud analysis, and other enterprise systems.

  3. Monitoring: Monitoring the system is vital because blockchain is a network, and any systemic impact—whether a technical or business exception—will affect the network and ecosystem participants. Also, you must satisfy regulations and generally accepted IT practices for purposes of high availability, capacity planning, pattern recognition, and fault identification.

  4. Reporting and regulatory requirements: This is the most important consideration, even for the interim adoption of blockchain as a transaction processing system. To meet these requirements, you should create connectors to an existing SoR to offload the reporting and regulatory requirements until the blockchain is enterprise-aware—or rather, the enterprise software is blockchain-aware.

  5. Authentication, authorization, and accounting requirements: Unlike in the permissionless world of the Bitcoin blockchain, in a permissioned enterprise world all participants must be identified and tracked, and their roles defined within the blockchain ecosystem. The topics that are part of this domain include the digital identities of the various individuals and business entities that participate in a blockchain network. Concepts such as a distributed or decentralized trust, digital identity, self-sovereign identity, consent management, and distributed access control (DACL) are evolving to address the various authentication and authorization needs of a blockchain network.

Blockchain for Enterprises

As we examine the facets of blockchain technology and their potential benefits to enterprise applications, we realize that the blockchain landscape is fragmented, with many innovative approaches in use to apply this technology to problem solving. This innovation leads to specialization, with each blockchain vendor offering a variant trust system, a different approach to one or more of the blockchain core components (such as the shared ledger, consensus, smart contracts, and cryptography) that addresses a specific business use case. These specialized vendors have defined business use cases that benefit from blockchain’s robust trust system, which allows for speed that matches the consumer’s expectations of the digital world. The tenets of blockchain—such as decentralized, distributed, global, and permanent code-based programmable assets and records of transaction—can be instrumental in managing such interactions, allowing them to keep up with the speed of the Internet.

As we contemplate the benefits of blockchain technology, we must also consider the adoption of blockchain by enterprises as a mainstream application transaction system. We suggest caution when using blockchain in enterprise application platforms that are burdened by legacy and evolving model-driven designs.

In this section, we attempt to demystify blockchain and outline the challenges that might occur when an enterprise adopts blockchain technology. We also focus on three primary areas that help describe blockchain in the context of an enterprise, as shown in Figure 3.2.

An illustration depicts enterprise blockchain.
Figure 3.2 Enterprise blockchain.

Enterprise View of Blockchain: Technology and Business Domain

When we discuss the technology landscape and enterprise adoption of blockchain, we should draw a distinction between permissioned and permissionless blockchain. Although this distinction is not simple, both types (and their variations) have a few things in common:

  • The technology components

  • The thematic elements of blockchain technology—that is, trust, transparency, and disintermediation

What is different between the two blockchain types is the business model and the resulting incentive economic model that govern the technology infrastructure:

  • The permissionless models rely on an incentivized economic structure that uses systemic crypto assets (such as cryptocurrencies) to maintain the ecosystem balance and participation.

  • The permissioned models use permissioned and identified entities and a network economic structure and are defined by the industry consortium business model (discussed in Chapter 4), which relies on compute equity.

Regardless of the distinction, blockchain technology is about networks and ecosystems. Whether you are discussing a peer-to-peer (P2P) permissionless network (like Bitcoin) or a business-to-business (B2B) permissioned network (like We.Trade), the end goal is a network that is supported by the appropriate equitable business model that facilitates the movement of assets and things of value with embedded trust.

P2P blockchains are generally open, so the “permissionless” label is an apt one: No one needs permission to join the network. In contrast, a permissioned blockchain is a network that attracts like-minded businesses and related business ecosystem players who need permission to join the blockchain. The term “consortium” is often used to describe an industry initiative that employs blockchain technology to either transform the industry or combat the disruptive forces of permissionless blockchains. Over time, industries have expanded the classification and the distinction between these two types of blockchains and added blockchain variations because of industry trends and business adoption of various public and consortium blockchain technology platforms and frameworks. New terms have emerged from this process:

  • Permissioned public

  • Permissioned private

  • Federated

  • Hybrid

  • Permissionless public

Figure 3.3 shows the types of blockchains.

A figure showing the types of blockchains.
Figure 3.3 Types of blockchains.

Blockchain is described as a digital trust web characterized by radical openness, where trust is achieved by using systemic transparency, immutability, and the collective validation of the network. Although openness works for cryptocurrency-based blockchains, other types of enterprises must consider the meaning and impact of radical openness on their businesses.

Public blockchain operates with decentralization and a simplistic compute paradigm that supports a widely distributed master list of all (currency) transactions that is validated by using a trust system supported by anonymous consensus. Can this trustless system be applied to an enterprise without modifying the fundamental tenets of blockchain? Can an enterprise use this disruptive technology as a path to its own transformation or as a vehicle to improve its existing processes and take advantage of the efficiencies of the trust system? In either case, the enterprise desires that the adoption of this technology beyond an experimental stage will not disrupt the current system because of the exponential costs and disruption to its existing operations. This poses an interesting challenge because the design inefficiencies of their current systems are precisely what compel enterprises to consider this paradigm shift in the first place.

Many of the use cases and government concepts that have been tested as proof points are still not usable by business enterprises. The financial services sector was the first to experiment with blockchain, but feared these efforts being disrupted by another wave of start-ups from Silicon Valley and Silicon Alley. Driven by consumer demands for speed and low-priced transactions, the financial industry has a defined structure of use cases that includes trade financing, trade platforms, payment and remittance, smart contracts, crowdfunding, data management and analytics, marketplace lending, and blockchain technology infrastructures. Soon, we suspect that its type of thinking might permeate other industries, such as retail, healthcare, and government.

Although blockchain technology combines many good ideas, it currently has limited visibility beyond cryptocurrency and lacks defined standards to promote interoperability between multiple-domain chains. Therefore, the technology requires that an enterprise establish a level of understanding that might lead to further innovations and standards (like ISO TC 307). This action might create unique opportunities to improve existing business practices (application of technology) and establish new business models by using a blockchain-based business network.

Litmus Tests to Justify the Application of Blockchain Technology

It is vital to ensure that the use case that you pick for applying blockchain is valid and justifies the investment into exploring blockchain as technology option. Blockchain addresses five aspects of the transaction-based economy:

  • Trade

  • Ownership

  • Trust

  • Transactions with digital assets (or tokenized assets)

  • Multiparty ecosystem and interaction

Although these tenets act as litmus tests for choosing the correct use case and problem domain, you must view the use case from a business perspective. Specifically, any chosen use case should meet two primary objectives:

  • Solve an existing enterprise problem. This problem should be significant enough for the enterprise to expend resources, time, and talent and have a defined return on investment (ROI). Also, the issue should focus on addressing an industry problem, such as securities lending, collateral lending, exchanges, or the supply chain. This decision justifies the investment and demonstrates that the use case is primarily driven by the enterprise’s cost objectives.

  • Solve an industry-wide problem. Such a problem concerns the network effect on the problem domain. The idea is that if an enterprise can solve the issues for itself, then perhaps it can apply the same acumen to solve the issue for the industry as a whole. This objective leads to determining the network effect—a quest motivated by the revenue objectives of an enterprise, including first market advantage, market leadership, industry transformation, and all the imperatives of the network effects of an ecosystem.

High-level technology considerations include the following issues:

  • Trust system and consensus technology: Consensus, mining, minting, consortium-specific consensus, cryptographic spectrum, and others.

  • Communication privacy on open networks: Cryptographic spectrum, encryption, channels, bilateral and multilateral communication, and the inclusion of regulatory and auditory roles.

  • Business integration systems: Integration into business and enterprise systems, which includes visibility into the stacks of processes.

  • Enterprise system integration: Meaningful integration with current and legacy systems by using the least disruptive path.

Chain Decision Matrix

Because the implications of this technology can be profound, an enterprise might want to devise a set of enterprise-specific criteria that can be applied to existing or new projects that use blockchain. Because of the versatility of blockchain technology and the current technological evolution curve, enterprises should use the chain decision matrix as a tool to ensure that an enterprise has a structured approach to apply a foundational technology to a business domain. This approach also enables a consistent blockchain infrastructure and trust management system, which proves vital as application-driven chains evolve and demand for enterprise visibility, management, and control grows. Figure 3.4 illustrates the components of such an enterprise blockchain platform.

An illustration shows the components of an enterprise blockchain platform.
Figure 3.4 An enterprise blockchain platform.

Technology, Business, and Regulatory Considerations for Blockchain

From a technological perspective, the design goals of adopting blockchain in any enterprise should focus on disrupting the incumbent system as little as possible. One way to achieve this goal is to think about integration with an enterprise system of record, which treats blockchain-driven transaction processing and the enterprise system of record as interfaces for other enterprise applications, such as reporting, business intelligence, and data analytics and regulatory interactions.

A design paradigm should also separate the blockchain technology infrastructure from the business domains that use blockchain technology. This approach establishes blockchain as an enterprise chain infrastructure that is invisible to businesses, while promoting enterprise synergy between the various business-driven chains. It also separates the business domain from the technology that supports it.

Blockchain applications should be provisioned by business domains that use an appropriate trust system that is applicable to the ecosystem for the business domain. Central to any blockchain endeavor is security design and consensus as well as the trust systems that are chosen. The system design should be appropriate to the business model of the blockchain network.

The chosen trust system also dictates the cost of the underlying infrastructure and the compute requirements. The distinctions between the blockchain technology infrastructure, the architecture of the pluggable trust system, the trust intermediaries, and the design allow a business chain to focus on the business and regulatory requirements. Economic viability and longevity of the blockchain network should be one of the primary design criteria. The technology infrastructure should be open, modular, and adaptable to any blockchain variant with specialized offerings, thereby providing manageability.

Enterprise synergy implies driving synergies between the various enterprise blockchains to enable inter-enterprise and intra-enterprise chain (cross-ledger) connections. With this type of model, the transactions cross various trust systems and various aspects of enterprise governance. In addition, control systems are visible to such interactions. The interactions between various business units and external enterprises are important to fractal visibility and are associated with the protection of enterprise data. Invisible enterprise chain infrastructures enable a solid foundation that leads to the evolution of enterprise connectors and the exposure of application programming interfaces (APIs) to enable incumbent systems to be chain-aware. Due to conditional programmable contracts (smart contracts) between the business chains, enterprise synergy flourishes.

Figure 3.5 illustrates the infrastructure elements of an enterprise blockchain.

An illustration shows the elements of an enterprise blockchain.
Figure 3.5 Example of an enterprise blockchain infrastructure.

Are enterprises picking the correct use cases to employ blockchain? More importantly, should the consideration of blockchain consumption focus on integration with incumbent transaction systems, or should blockchain technology infrastructures be enterprise-aware? An integrated enterprise needs more than one specialized use case, and it needs to drive enterprise synergy to fully realize the promise of enterprise blockchain. The use cases should be based on fundamental technical tenets and paired with the correct business economic models that support sustainable growth. The technical success of blockchain consumption should initially focus on technology, and enterprises should consider integration with existing enterprise business systems to ease the collective understanding of this technology while establishing a path of least disruption and accelerating enterprise adoption.

Essential Maturity Imperatives for Enterprise Blockchain

Although the early days of blockchain were all about disruption, education, understanding, investment, and business models, this model now needs to mature and reap the benefits of what industries wanted to achieve: an efficient system with built-in trust that leads to an efficient marketplace based on the efficacy of the technology application. In this section, we go back to basics and focus on the fundamentals of time and trust and the blockchain tenets of trade, trust, and ownership.

Our many client engagements have led us to realize that we still must focus on fundamentals to truly engage in a digital transaction system that includes verifiable digital identity, tokenization of assets (into digital assets), and digital fiat (another digital asset as a settlement vehicle). This focus ensures that we cover the bases of societal elements, such as verifiable claims, nonrepudiation, defining and verifying ownership, and mapping physical assets to digital assets (through tokenization). Moreover, it ensures that the governance system is the result of a robust system design that prevents wrongdoing and fraud and provides confidence that the resulting economic and financial system is ready for the digital age.

Essential elements for enterprise blockchain maturity include the following:

  • Digital identity as a foundation technology to ensure the trade and ownership tenets of the blockchain system. We need digital identity to assign ownership to a digital asset.

  • Digital fiat to address the last-mile issue of settlement for every financial transaction and every financial services use case. Money of fiat as a settlement instrument must be digitized to keep pace with the digital transaction network.

  • Asset tokenization to ensure that digital manifestations reflect real-world assets. A technological platform must ensure that the assets are digitized, are unique in a system, cannot be replicated and maintain their integrity to hold value, and preserve transfer value.

  • Security design of the blockchain system to address nonrepudiation, privacy, confidentiality, and verifiability of claims with consent-driven models.

  • Business of blockchain business models to ensure that regulated and enterprise systems can find the correct business model to advance the agenda of blockchain-based business networks.

  • A governance model, which may range from a self-governance network to a consortium-defined semi-autonomous governance structure. Again, you must find the correct governance model necessary to progress the agenda of blockchain-based business networks.

Figure 3.6 depicts the essential elements of an enterprise blockchain.

An illustration depicts the essential elements of an enterprise blockchain.
Figure 3.6 Essential elements of an enterprise blockchain.

Token Revolution

Asset Tokenization: Essential to Powering the Next-Generation Digital “Instance” Economy

One of the core value propositions of a blockchain-powered network is the resulting co-creation elements, such as the digital transaction system and the value-driven ecosystem and marketplace. Asset tokenization is essential to powering the next-generation digital economy and paving the way for new business models that are built on the “instance economy.” To explore this topic, let us begin with some background.

Earlier, we discussed the challenges of the permissionless world, which does not adhere to any conventions and forges ahead with many innovations that are bound to disrupt many industries. Those changes may be advanced either through new business designs (e.g., initial coin offerings [ICOs]) or by conventional industries attempting to adopt the technology to either transform the industry or beat or keep up with disruption.

This combination of technology-driven platforms and the use cases that depend on them rely on the manifestation of value. Digitization—whether it is systemically generated in the form of a transaction utility coin or a layer-two token that relies on the underlying coin for its value—is nothing but a notation of an instrument that has a real or perceived value.

The genesis of blockchain as a permissionless system relied on a technology-based systemic governance composed of incentives and mechanisms of coordination. This systemic governance has its own set of challenges when it is used in enterprise business networks that attempt to use the tenets of blockchain technology. In the enterprise world, which is regulated and relies on permissioned blockchain models, the checks-and-balances system is complicated by transactions between competing entities that use regulated data and have a fiduciary responsibility. Such permissioned models cannot account for the tangible or systemically generated incentives (crypto-assets) or have network-wide mechanisms of coordination due to privacy and confidentiality issues. Figure 3.7 provides a view of the various types of blockchain and industry use cases.

An illustration shows the types of blockchain and industry use cases.
Figure 3.7 Types of blockchain and industry use cases.

Introduction to Tokenization: Understanding the Token Revolution

Blockchain technology lays the foundation for a trusted digital transactional network that, as a disintermediated platform, fuels the growth of marketplaces and secondary markets due to new synergies and co-creation that come from new digital interactions and value-exchange mechanisms. Although blockchain itself provides the technology constructs to facilitate exchange, ownership, and trust in the network, it is in the digitization of value elements where asset tokenization is essential. Let us take a closer look.

Digitization is the first step in many enterprise and permissionless blockchain projects. Tokenization is the process of converting the assets and rights or claim to an asset into a digital representation or a token in a blockchain network. Note that there is a difference between an (crypto) asset or currency and a tokenized asset.

A (crypto) asset or currency is a medium of exchange or a protocol-driven exchange mechanism that embodies the same characteristics of a real-world currency, such as durability, limited supply, and recognition by a network, while being backed by a common belief system (like a fiat currency). A (crypto) asset or cryptocurrency also represents a by-product of trust systems (consensus) used as a vehicle to back the incentive economic model that rewards and fuels the trust system of a network, making it a trusted currency of the network.

Conversely, a token can be many things: a digital representation of a physical good, making it a digital twin of that good, or a layer-two protocol that is based on the (crypto) asset or currency and represents a unit of value. This distinction is important to understanding how the exchange vehicles, valuation models, and fungibility work across the various value networks that are emerging, which in turn poses challenges around technical interoperability and equitable swaps.

Asset tokenization presents interesting technology challenges:

  • Ensuring the integrity of physical assets, such as containers, gold bars, or cars

  • Ensuring that if a token will be the digital twin of a physical asset, the physical asset movement is seamlessly linked to the token movement in the digital network

  • Ensuring uniqueness and integrity of the token in and across the network

  • Ensuring the token’s ability to hold, transfer, and preserve the value of underlying assets that the token represents

  • Effectively managing the life cycle of the token in the business network

  • Using tokens effectively with the asset class and the economic and business models that govern the asset class

  • Ensuring the privacy-preserving characteristics of the token and the assets that it represents

  • Ensuring cross-ledger token resolution and token life-cycle and governance systems

  • Preserving value while transferring value to other value networks and secondary markets

These challenges can be addressed by deploying well-designed solutions that use blockchain constructs to embed trust and other adjacent technologies, such as tokenization platforms, registries, token vaults, and detokenization systems. We can rely on proven blockchain solution design practices to ensure the integrity, uniqueness, and value preservation of tokens in a network.

We are seeing the rise of new intermediaries when it comes to exchanges of the “value” that these tokens embody in a network with other value tokens. These intermediaries come in various forms, ranging from token exchanges, to decentralized exchanges, to network “asset” bridges, to token registries and repositories. These intermediaries solve a token fungibility issue, but they create the same set of cost and settlement challenges of current value-exchange systems.

Many different token types and classifications exist today. Although there is no standardized nomenclature, all these tokens have one thing in common: They represent and digitize value. Some of the token types include the following ones:

  • Pegged tokens

  • Stable coins

  • Tokenized securities

  • Security tokens

  • Utility tokens

  • Collateralized and decentralized tokens

  • Non-collateralized and decentralized tokens

  • Collateralized and centralized tokens

  • Initial coin offering (ICO)

  • Security token offering (STO)

Various Industry Definitions

Here are some definitions of tokenization from industry sources:

This is where stable coins come in. Stable coins are price-stable cryptocurrencies, meaning the market price of a stable coin is pegged to another stable asset, like the US dollar.2

Preston Byrne: A stable coin claims to be an asset that prices itself, rather than an asset that is priced by supply and demand.2

In their most simplistic form, stable coins are simply cryptocurrencies with stable prices measured in fiat currency.3

Types of stable coins: fiat collateralized, crypto collateralized, non-collateralized, collateralized decentralized, collateralized centralized, pegged, and so on.3

Tokenization is a method that converts rights to an asset into a digital token.4

Tokenization is the process of converting rights to an asset into a digital token on a blockchain. There is great interest by financial intermediaries and technologists around the world in figuring out how to move real-world assets onto blockchains to gain the advantages of Bitcoin while keeping the characteristics of the asset.5

The varying industries (crypto and financial services and analyst communities) have varying points of view and definitions. This diversity makes it incredibility difficult to define concepts like technology or digital assets or traditional and conventional risk models.

Now that we have explored the token revolution and drawn a distinction between (crypto) assets and currency, let us explore the token valuation models and why they are important.

Token Valuation Models and the Instance Economy

Although an (crypto) asset or currency derives its value as a medium of exchange within a shared common belief system of a network (often confined to that network), tokens might have complex and fragmented valuation models. Many coins (started by ICOs and STOs) that aspire to morph into their own crypto assets, either as utility or security tokens, rely on the community to develop and recognize value. In contrast, many other tokens are only digital representations of the assets that they represent.

Assets today, such as stocks, bonds, securities, mortgages, and mortgage-backed securities, are difficult to transfer or subdivide physically, so buyers and sellers instead trade paper (or digital records) that represents these assets. The issue with paper (or digital records) and their accompanying complex legal agreements is that they are cumbersome and pose a challenge to transference and tracking, leading to opacity, fraud, opportunity, and transaction costs. One solution is to switch to a digital system that uses digital assets, such as tokenized assets on a blockchain network, but linked to an asset.

It might be prudent for us to classify these token valuations by either industry type (such as nonfinancial, supply chain, or financial services) or asset type (dematerialized, virtual, real asset, and others). Such a classification is necessary to establish a trail of governance with checks and balances and to represent some industry-recognized valuation systems. With this approach, it might seem as if all that we are achieving from tokenizing assets on blockchain networks is mimicking or creating a digital twin of current value networks, and that a fiat currency, although it addresses the duality of a transaction, can be replaced by a cryptocurrency (including digital fiat). In reality, the promise of blockchain-based business networks is not just about digitization and solving the inefficiencies of time and trust, but also about creating new business models and co-creation that capitalizes on the synergies of the network participants.

Thus, we see the introduction of the instance economy and secondary markets that are fueled by the instances of an asset. Tokenization of assets can lead to creation of a business model that fuels fractional ownership or the ability to own an instance of a large asset. Fractional ownership opens a market to participation from entities that were prevented from participating due to high capital requirements or the opacity of the value transfer systems. Furthermore, fractional ownership opens up a new range of asset classes and asset types, unlocking the economic value of capital that could not previously be accessed as investment opportunities.

We use the term instance economy because this type of economy fuels the tokenization of assets, which leads to the ownership of an instance of an asset class. This approach creates markets and secondary markets of value.

Although blockchain provides the technology constructs to facilitate exchange, ownership, and trust in the network, it is in the digitization of value elements that asset tokenization is truly essential. Tokenization is the process of converting the assets and rights or claims to an asset into a digital representation, or token, in a blockchain network. The distinction between cryptocurrency and tokenized assets is an important construct for understanding the exchange vehicles, valuation models, and fungibility across various value networks that are emerging. These networks pose challenges related to technical interoperability and equitable swaps. Tokenization of assets can lead to the creation of a business model that fuels fractional ownership or the ability to own an instance of a large asset. The promised asset tokenization within blockchain-based business networks depends on digitization and solving the inefficiencies of time and trust, and it creates new business models and co-creation from the synergies of the network participants.

Understanding Digital Asset (Token) Fungibility: Opportunities and Challenges Related to Token Valuation and Blockchain Ecosystems

Since the early conversations about crypto assets and blockchain, there has been a significant change in attitudes toward crypto assets and the industry’s willingness to work toward solving the issues regarding the trade, payment, and movement of (digital) goods and money. Some of the industry’s focus has centered on the economic viability of solutions, business models, and governance, and the fundamental tenets of blockchain and its correct use in use cases, such as the following ones:

  • The payments landscape: Retail, wholesale, interbank, and cross-border issues.

  • The relevance to GPI Phase 3 and blockchain’s role regarding Nostros Vostro.

  • Stable coin and digital fiat: Payment innovation, payment velocity, and emerging business models.

  • Innovation in B2B products, such as accounts payable, accounts receivable, and B2B money transfers.

Although we are building a value network that can transfer value with embedded trust and transparency, in many cases the value is created by using the principles of crypto economic models (mining, minting, or simply induced value) or, in the case of permissioned networks, by introducing asset tokenization. You should understand the primary drivers of value in a blockchain network, which inform the understanding of the core tenets used to evaluate the economic value of blockchain entities. The drivers of valuation include the following possibilities:

  • Tokens that are driven by crypto economic models, which are themselves driven by supply and demand and the utility of the network.

  • Non-fungible tokens (NFTs) that have an intrinsic value, such as identity, diplomas, and healthcare records. Such tokens are simple proof-validations of the existence, authenticity, and ownership of digital assets.

  • Fungible tokens that are valued by the total of economic activity in the network (cryptocurrency); their utility (smart contracts and transaction network processing); their assigned values, as in stable coins and security tokens; and so on.

At this point, we must define and understand tokenized value. Many different token types and classifications exist, all of which share one thing in common: They represent and digitize value.

Defining Fungibility

In economics, fungibility is “the property of a good or a commodity whose individual units are essentially interchangeable.”6 That definition has implications for the blockchain world, owing to its reliance on tokens and their economic models. In this section, we explore two fundamentals of token-based systems:

  • The token evaluation model

  • Token fungibility and asset exchange mechanisms

The Token Evaluation Model

The token evaluation model determines the value of a systemic asset. Put simply, if we choose to engage in economic activity such as transaction processing and use the asset as a currency, or if we use tokens as a utility or security, we must know what the asset or token is worth!

Considerations for evaluating the economic values of blockchain companies include the following:

  • Business solutions:

    • Problem domains: What is the business problem that we are solving? What is the industry landscape? What is our evolution through innovation?

    • Addressable markets: What is the overall cost of problem domains? For example, what is the cost of the problem itself or industry subsegments?

    • The regulatory and compliance landscape: The regulatory landscape can help or impede the adoption of new technology-led business models.

    • Competitive frameworks and alternatives: How are the other framework entities trying to solve the issue with or without DLT or blockchain?

  • Technology design and architecture:

    • Consensus design: This approach leads to trust systems and the economic viability of the blockchain network.

    • Blockchain tenets: Shared ledgers, crypto elements, smart contracts, and security elements are foundational concepts.

    • Blockchain deployment infrastructure: The cloud, geo-specific deployment, technical talent (or access to it), service level agreements (SLAs), and other components must be defined for the network.

  • Monetization strategies:

    • Token-based models: Operation fees are used to write to the blockchain-powered business network’s distributed database.

    • Tokens as a medium of exchange: Participating entities lend or sell tokens as a step-through currency.

    • Asset-pair trading: This practice monetizes margins.

    • Commercialization of the protocol: Technology services include the cloud and software, lab, and consulting services.

The Power of Networks

We can extrapolate the power of networks and the exponential power of co-creation models to create new business models and produce economic value.

Token Fungibility and Asset Exchange Mechanisms

You must understand token fungibility and asset exchange mechanisms to understand the duality of transaction processing—that is, exchanging the (digital) value of things that are worth trading. With fungibility and asset trading, every crypto asset is confined to its network of origination. Without a measurable and defined valuation model, it is impossible to determine the real value of these crypto assets or tokens, regardless of their classification, which implies that the exchange is a speculative value. It is difficult to create a sustainable economic ecosystem or marketplace based on speculation.

Various approaches to dealing with asset exchange have been proposed that provide businesses with fungibility and asset exchange models:

  • Centralized exchanges: Centralized entities that do not use or conform to the decentralized nature of blockchain technology. The business model is based on an intermediary that provides specialized exchange services for crypto assets.

  • Decentralized exchanges (DEXes): DEXes address the disintermediation of centralized exchanges, which remove cost and friction while specializing in exchanging services for crypto assets. DEXes adhere to a decentralized model and enable peer-to-peer exchanges. For example, atomic swaps and atomic cross-chain trading entail the exchange of one cryptocurrency for another cryptocurrency without a trusted third party.

  • Cross-chain transactions: Transactions between various token types that ensure that the integrity of assets (and transactions) is preserved when the token or its definition moves across networks.

  • Asset bridging: Like cross-chain transactions, asset bridging addresses the issue of a token that remains confined to its network due to its creation, validity, and life cycle. With technology such as asset locks, the bridges ensure that locked assets are not traded and do not change ownership.

You must determine the value of a systemic asset for a simple reason: If we choose to engage in economic activity, such as transaction processing by using an asset as a currency or by using tokens as a utility or security, we must know their worth. Fungibility and subsequent asset trading bring an interesting dynamic to the crypto asset world, because every crypto asset is confined to its network of origination. Without a measurable and defined valuation model, it is impossible to determine the real value of these crypto assets or tokens, regardless of their classification, which implies that the exchange would be just a speculative value. As noted earlier, it is difficult to create a sustainable economic ecosystem or marketplace based on speculation. The industry has adopted various approaches to enabling asset exchange, thereby providing a fungibility and asset exchange model that supports a more concrete market structure—one not based solely on speculation. The challenge lies in defining the correct evaluation model and choosing the correct option to enable token fungibility and facilitate exchange. Great opportunity can be found in technological advancement and the resulting business opportunities, such as first-market advantages and enabling new industries and business models.

Considerations for Meaningful and Sustainable Blockchain-Powered Business Networks

The long-term promise of blockchain as a business network implies a trusted platform for disintermediation that leads to market and cost efficiencies. Blockchain market share, which includes both technology and those industries that use the technology in the networks and ecosystems they initiate, is defined by the evolving valuation models of business networks.

In this section, we discuss the evolution of meaningful and sustainable blockchain-powered business networks. The work that the industry (technology companies, fintech start-up ecosystems, and industry consortia) has done in the past few years largely focused on maturing the technology and promoting adoption of the technology by enterprises and businesses as a means to solve current problems and pave the way for new business models (enterprise and subsequent industry focus). As the industry and enterprises realize the potential of blockchain technology and reimagine today’s business networks, which are laden with archaic processes, paper- and document-driven processes, and systemic costs, they must also address long-term considerations related to adopting the blockchain-powered business network.

To use blockchain effectively, you must consider other mechanics of the business network:

  • Choice matrix of consensus models: The industry must develop a choice matrix for consensus models that define the trust system, collusion vector, associated computation costs, and infrastructure investment necessary to support the trust system that defines the business network.

  • Systemic industry governance: Technology and industry-specific governance is necessary for the systemic digital assets, industry-specific requirements, and business systems that govern the movement, whether permanent or temporary, of digital or tokenized assets within a specific ecosystem. Essentially, such governance defines which entities can do what, who is responsible, and who investigates if a system anomaly arises. These questions, which are industry-specific concerns, must be codified in system design and network initialization.

  • Asset tokenization, control, and governance: Industry-specific elements are needed to govern asset issuance, collateralization, proof of ownership and existence, and audit requirements so as to ensure the integrity of the real assets in the system. The idea is to weave checks and balances into the system that control supply and demand and establish an audit trail to maintain systemic trust in the business network.

  • Decentralized authority framework: The notion of decentralized control and authority is tightly linked with the trust system. Of course, in a decentralized system, the notion of authority does not work well. The focus of this design principle, therefore, is on governance, culpability, and regulations.

  • Decentralization and security considerations: Decentralization and distributed ledgers have various trust advantages, such as a transparency, immutability, and network-wide transaction processing. Although these advantages lend themselves to the overall trust framework, they can also create enterprise challenges concerning distributed data, as well as business insights that can provide a competitive advantage to some participants and a disadvantage to others. The security design imperative is to factor in enterprise security while addressing the new security challenges imposed by a shared business network. Cybersecurity risks and vulnerabilities are high-focus areas.

Business networks are industry-, industry segment–, and asset-specific networks, which implies that no single dominant blockchain controls all other blockchains, and that many blockchain business networks exist. A blockchain network can focus on a plurality of business domains, such as mortgages, payments, exchanges, and clearing and settling specific asset types. In enterprise blockchain, these projects take place within a centralized (in a decentralized context and application design patterns) network that is a consensus consortium between like-minded business entities. This assumption is based on many practical factors:

  • Industry-, segment-, and asset-specific business language: This language defines the smart contract, asset definition, and control and governance of smart contracts as a proxy business representation.

  • Industry-specific asset control: This factor defines governance, management, and valuation (for asset exchange, asset fungibility, and others) of digital (representation or) tokenization of assets.

  • Industry- and region-specific regulation: Most business networks are both industry- and region-specific in their scope. In regulated industries, a business network is regulated separately in terms of the burden of adherence, compliance, and related costs that are shared in the business network.

  • Industry-specific business functions: Most industries have their own measurements, standards, and statistics that represent performance indicators, such as analytics and market data.

For enterprises today, the blockchain-powered business network is limited by the current business network. The business design impacts the technology design, and a technology design might affect business network sustainability. If the system design of the business network is not aligned with the tenets of blockchain (i.e., trade, trust, ownership, and transactionality in a multiparty scenario), the greatest strengths of blockchain might become its greatest weakness, and the business network might never fully realize the promise of blockchain networks.

Enterprise Integration: Coexisting with Existing Systems of Record

Integration of blockchain with the enterprise system is a business and technology consideration due to downstream transaction systems that feed into and rely on critical business and operation systems. Various blockchain project evaluations have revealed that adjacent system integration has a significant cost impact on blockchain projects—and if you do not address these costs early in the planning stages, they may negatively affect enterprise adoption. Such impeding elements can disrupt the enterprise’s operations. Moreover, the various fragmented systems that may have evolved as extensions (innovations) of the legacy system due to changes in business models, business process innovation, and advancement in technology can present challenges for blockchain integration.

We also must account for adjacent enterprise systems that require enterprise integration for blockchain applications and have operational implications. In the best-case scenario, the elements of trade, trust, and ownership, and the inherent properties of blockchain, such as immutability, provenance, and consensus, will foster a trust system that aids in eliminating redundant and duplicative systems and processes; such duplicative systems carry costs for the enterprise in terms of significant allocation of resources, leading to delayed transaction processing and associated opportunity costs. Our goal should be to address the fundamental problems of the existing process, leading to a flat and transparent ledger that aims to address the element of trust and time, significant costs savings, and better client service.

Blockchain Network Extensibility

Extensibility is defined as “a system design principle where implementation takes future growth into consideration.”7 It is a systemic measure of the ability to extend a system and the level of effort required to implement the extensions.

Blockchain business network design should aim at extensibility because of the dynamic nature of the business (regulation, competitive pressures, market dynamics, and others) and network growth due to inclusion of new entries, such as new ecosystem participants, as well as existing players (regulators, market makers, liquidity providers, fungibility providers, service providers, and others). Several factors must be taken into consideration regarding network extensibility in blockchain system design:

  • Extensible membership models: The design must support the inclusion of a diverse set of participants, the volume of participants, and the desired transaction processing capabilities. As the industry changes, so does business, which in implies changes in the members that join the network. The network must be designed to onboard and cope with membership changes in the network. Various network participants might want to join or leave the network. The mechanics of membership changes include access to (shared) data, which must be considered in the design. The member type is also an important consideration, because the roles and type of member might change as blockchain either disrupts or disintermediates certain membership types.

  • Trust system viability—compute equity versus network economic incentive: The appropriate trust system choices for a permissioned (public or private) network and its impact on infrastructure investment and economic viability are important because there is a divide between trust systems based on crypto assets (based on crypto economic models) and trust systems based on compute equity (or non-cryptocurrency). We must consider the long-term sustainable infrastructure costs and maintenance, which are directly related to the types of participants and their business interests in the business network. For example, the cost models of a regulator are different from the cost models of the primary beneficiary of the blockchain-powered business network.

  • Shared business model—shared costs and shared benefits: Because a blockchain-based business network is a network and ecosystem, it features shared business processes instead of flattened business processes. A blockchain-powered business network has specific business advantages, such as reduced risk, a reliable and predictable transaction network, and a reduced cost of compliance, which collectively lead to good ROI ratios.

However, shared business interest leads to other operational considerations, such as data sharing and data ownership as entities join and leave the network. The regulations around data ownership may also change from time to time, along with industry requirements regarding the durability of data. The shared cost of infrastructure, compliance, and efficiencies due to flattened business processes on a blockchain network are clear advantages of this approach, but these efficiencies can be achieved only with a sustainable structure of a business network and the correct economic models.

Blockchain Project Sustainability

Many design areas—such as business models, technology design, the trust system choice matrix, devising and employing a governance structure, and continual system analysis—are paths to ensure early success with blockchain project deployment and long-term sustainability. The idea is to design a robust, extensible, and organic system that can grow with the changing demands of a business ecosystem, and not be locked into a technology with limited flexibility.

Factors such as scale, security, data visibility, and network extensibility can be exploited to create a sustainable business network. After the network evolves and grows, there is no turning back regarding systemic issues, such as a trust models, data visibility, and competitive advantage while using the network for the shared costs of doing business. Maintaining a substantive focus on sustainability is a complex and paradoxical quest: It promotes open collaborative innovation while locking down some of the constructs, such as consensus or trust systems, and governance systems that govern the assets, smart contracts, and overall interaction in a multiparty transaction network.

As we debate the merits of signing transactions versus mining transactions to establish trust in the network, note that a blockchain-powered business network is limited by the limits of the current business network as it evolves. This is not a technology problem, but rather a business ambition issue. If the system design of the business network is not aligned well with the tenets of blockchain (trade, trust, ownership, and transactionality in a multiparty scenario), the greatest strengths of blockchain might become its greatest weakness, and the business network might not fully realize the promise of blockchain networks. Wise choices for factors such as scale, security, data visibility, and network extensibility, however, can lead to a sustainable business network.

Chapter Summary

This chapter discussed the overall blockchain technology landscape and addressed the trust divide between an enterprise (permissioned) blockchain and a public (permissionless) blockchain. It is vital to understand the technology underpinnings of the trust systems, which lay the foundation for trustless interactions between various participants within a network. Enterprise blockchain design and enterprise integration will inevitably impact the cost of the solution deployment and the longevity of the application, so economic incentives are a vital component of any blockchain network. This distinction is vital for the valuation of crypto assets and to ensure the continued and sustained growth of a blockchain-powered business network.

References

1. Bellare, Mihir; and Rogaway, Phillip. (September 21, 2005). “Introduction.” In Introduction to Modern Cryptography (p. 10). web.cs.ucdavis.edu/~rogaway/classes/227/spring05/book/main.pdf.

2. hackernoon.com/stablecoins-designing-a-price-stable-cryptocurrency-6bf24e2689e5

3. medium.com/@argongroup/stablecoins-explained-206466da5e61

4. medium.com/coinmonks/asset-tokenization-on-blockchain-explained-in-plain-english-f4e4b5e26a6d

5. www.nasdaq.com/article/how-tokenization-is-putting-real-world-assets-on-blockchains-cm767952

6. www.investopedia.com/terms/f/fungibility.asp

7. www.w3.org/Protocols/Design/Interevol.html

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