cnBlog – Blockchain use cases outside of digital currencies

Blockchain technology is closely associated by the public with crypto assets, such as the most well-known, Bitcoin. In his blog post, Alexis Derviz from the Monetary Department explores its use in areas outside digital currencies, such as security and the protection of property rights.

Published in Global Economic Outlook - August 2024 (pdf, 1.5 MB)

Introduction: why are distributed ledgers demanded

Distributed Ledger Technologies (DLT) are decentralised algorithms to manage digital logbooks containing records of assets and transactions across multiple participants or nodes within a network. The two essential elements DLT needs in order to ensure the integrity, immutability, and security of recorded information are cryptography and consensus algorithms for the network updates. Instead of one authority controlling data, DLT shares the ledger among participants, ensuring record transparency. Therefore, DLT are routinely offered as a remedy whenever bookkeeping mistakes, entry manipulation and/or past record credibility are both a major concern and an issue not satisfactorily resolved by legacy technologies. Among frequently named objectives of DLT engagement are fraud reduction, know-your customer (KYC) requirements and cyber security. Indeed, a distributed ledger with a timestamp and batches of specific transactions with a link to another block make it increasingly hard for the hackers to break into the system without the breach source and time getting exposed. Further, KYC procedures in banking, aimed above all at combating money laundering and terrorism financing, are quite expensive to comply with. The verification time and cost of data stored on a DL network, typically a blockchain, are expected to be lowered by manifold. Finally, cases of human error, data losses and hacks are ubiquitous when business data are stored on traditional centralised servers. Putting data on a DL would usually reduce the corresponding losses dramatically. However, for an individual company, infrastructure build-up and maintenance costs may be prohibitive in view of the needed specialised in-house expertise. Here, the Blockchain-as-a-Service (BaaS, Nuseibeh, 2023) model promises a way out. BaaS allows businesses to use cloud-based solutions to build, host and use their own blockchain apps on the infrastructure developed by a vendor. Altogether, compared to the early years of blockchain, the palette of current applications in terms of market size has become quite rich (Figure 1).

Figure 1 - Most popular blockchain technology application areas in 2022
(market size is 10 bln. USD)

Source: https://4irelabs.com/articles/blockchain-applications-use-cases-in-business/

In terms of architecture, blockchain is the original and best-known type of DLT. In it, events are stored linearly in blocks and sequentially validated by so-called miners. The notorious problems of the first blockchains with processing speed, resource consumption and scalability motivated experiments with alternative, non-linear data structures. DLTs based on Directed Acyclic Graphs (DAGs, Jungnickel, 2012) are the most actively explored alternatives. Compared to blockchains, their main advantages are asynchronous (and hence more parsimonious) validation algorithms, shorter confirmation times, and easier scalability. For example, a non-mining approach to transaction validation in a DAG-based system is known as Hashgraph, multilevel decentralisation (when each node becomes its own blockchain with locally enforced rules) is attempted by Holochain, etc. However, conceptual difficulties resulting, e.g. from non-trivial topological properties of DAGs (Bang-Jensen, 2008) have so far constrained their applicability outside specialised data-processing systems, e.g. in healthcare and genetics.

Thanks first to Bitcoin and then other crypto currencies and cryptoassets that followed, people often interchange DLT and blockchains and awareness of DLT diversity remains limited. On the other hand, the widespread understanding is that even the original blockchain concept of data organisation is potentially able to deeply transform numerous industries and activity areas. This is why BigTech companies (such as Apple, Google, IBM and others) buy up blockchain startups and also invest in this technology in-house, as do other corporations outside the tech branch (e.g. Coca-Cola, Porsche).^[1] Paradoxically, part of the inspiration behind the blockchain development was distrust in corporations and the hope to create an alternative interaction mechanism that would operate in a completely trustless environment. However, as time passed, the proliferation of corporate blockchains once again confronted users with the necessity to trust the central entity whose chain they have decided to access.

Users currently need to distinguish between public vs. private, permissionless vs. permissioned chains. This is because, although the data in every blockchain are transparent to all stakeholders, it still must be decided who can become one. In this regard, one encounters public (everyone can access and initiate transactions) and private (access and use are sanctioned by a designated authority), permissionless (algorithmically in-built ledger updates directly follow from the participants´ actions without further outside authorisation) and permissioned (these updates can be only conducted by pre-selected parties). There also exist multiple hybrid cases (Chatterjee, 2024). The first blockchains to attract widespread public attention, i.e. those on which cryptocurrencies such as Bitcoin and Ethereum exist, are both public and permissionless. On the contrary, when businesses, organisations, and government agencies seeking to combine security with a limited degree of record-keeping transparency resort to this technology, they rely on private and permissioned blockchains. Also trade with other digital, or tokenised real, assets often happens on private blockchains. When participants have differentiated rights, as is mostly the case in financial applications run by banks, one also speaks of hierarchical chains, with the extent of ledger information access and update permissions differing across participant tiers (e.g. Dragonchain). A popular example is the modular framework of Hyperledger Fabric (Investopedia, 2023), a private, permissioned umbrella application designed with the purpose to connect public chains. One subtype of hierarchical, or hybrid category currently gaining weight in finance are consortium blockchains, in which the founding consortium members (typically banks) hold the full access and ledger update rights in the original blockchain sense, whereas clients of individual consortium members only enjoy limited viewing, access and transaction-initiation rights corresponding to their stakes in the system.

Figure 2 - Venture capital investment in crypto asset start-ups, 2016-2023
(bn. USD; rhs: count)

Source: https://www.galaxy.com/insights/research/crypto-and-blockchain-venture-capital-q3-2023/

Widening the scope of permissionless blockchain abilities

Whereas Bitcoin, from its inception to this day, has remained the tool of value exchange and speculation untethered by state laws and conventional financial regulation, the second most widespread chain, Ethereum, strives to offer a wider scope of services, most importantly smart contracts. The latter are self-executing algorithms representing agreements between the network participants with terms and conditions directly written into code. Blockchain enables the verification and automatic execution of these contracts, reducing the need for intermediaries and enhancing the efficiency of various business processes. Also today, Ethereum keeps the position of the most widely used chain offering its users smart contracts, even though competition (Solana, Cardano, BNB Smart Chain, Polygon, Polkadot, Hyperledger Fabric) is steadily increasing.

On the downside, legal implications of smart contracts remain controversial. For example, they may enable ownership transfer in disregard of legal restrictions. Since state-changes of a blockchain are immutable, it is unclear how a nullification or reversal of an illegal transaction can be effectuated according to the blockchain- and smart contract-conform principles. Further, decentralised oracle networks enable smart contracts to access real-world data such as market prices, economic statistics, weather, etc. If an oracle providing such data malfunctions or its inputs are manipulated, are the affected parties entitled to damage restitution? These issues should normally be settled in courts, but the uncertain legal status of smart contracts raises concerns around enforceability, as well as consumer and investor protection in general. The difference between maintaining ownership rights in the on- and off-chain environment is exemplified by the (uneven) evolution of two crypto asset categories: security and utility tokens.

Blockchain-stored security tokens provide ownership rights in real-world assets. They allow for a transfer of value from an asset or bundle of assets to whoever holds the private keys to the token. In other words, security tokens are a decentralised digital form of traditional investments. However, in view of the strict regulatory oversight they are facing, these tokens are not yet available to retail investors, notwithstanding the hard efforts of many institutions to get them approved by regulators. Therefore, as a provisional solution, instead of Ethereum, security tokens may well take off as applications reserved for customers of the involved financial intermediaries and residing on private permissioned blockchains operated by market infrastructure providers, often with a hierarchy of rights and functions.

Unlike security tokens, utility tokens do not provide any ownership or investment stake in a project. They are a special kind of blockchain-based virtual currency that gives access to the specialised products or services the company plans to deliver. This helps issuing companies to raise capital, whereas interested investors are rewarded for their contribution in a verifiable and presumably tamper-free way. Importantly, utility tokens are used for various purposes within the blockchain ecosystem, e.g. transaction fee payments, premium service access, or governance and decision-making process participation. From a legal point of view, they have so far operated within regulatory grey areas. The earliest examples of utility tokens include Ethereum's gas token, which is used to pay transaction fees on the Ethereum network, and Binance Coin, which is used to pay trading fees on the Binance cryptocurrency exchange.

In an area not directly related to markets and trading, many proposals are heard on how to revolutionise voting systems by providing a transparent and tamper-proof blockchain-based platform for elections. Each vote would be recorded as a transaction on the pre-selected public blockchain, preventing any alteration or manipulation. This mechanism is supposed to ensure the integrity of democratic processes and enhance voter trust. Actually, in a somewhat less ambitious proposition, a private, instead of a public, blockchain within an organisation can equally transparently and credibly assist the conduct of opinion polls, surveys and elections by the employed.

Non-fungible tokens, protection and monetisation of intellectual property

According to proponents, blockchain offers a secure way to record and manage intellectual property rights. Artists, writers, and other creators can presumably timestamp their work on the blockchain, providing indisputable proof of ownership and protecting their creative assets from infringement. A practical implementation of this idea is related to the advent of non-fungible tokens (NFT, Sharma, 2024). An NFT is a blockchain-based asset representing ownership of a unique (hence the term non-fungible) digital or physical item. (On the contrary, the previously discussed utility tokens are fungible.) The NFT concept originates in a token standard on Ethereum, and, in view of the powerful network externality following from the user base size, the latter remains the dominant chain of their residence. There is a range of views on what NFTs may represent. On the one hand, NFTs are thought to be a revolution in how digital assets are marketed and monetised. On the other, critics regard them as a fad fueled by celebrities, or a money-laundering or tax-evasion scheme. The regulation of NFTs is in an early phase of evolution.

Intellectual property protection by means of an NFT is certainly innovative and conforms to the digital era, although it requires that authors accept the necessity to become on-chain merchants themselves. Indeed, NFT are the key element in the digitalisation of artwork trade. Art markets have been known for a lack of transparency, costly and error-prone provenance and copyright verification procedures, high fees and low liquidity. Tokenisation, along with a flexible and extendible infrastructure, is offered as a way to create immutable registries, copyright records, certificates, etc. Enthusiasts also expect that, thanks to NFT, efficient secondary markets with instant liquidity and low fees will soon develop.

If, instead of non-fungible, one allows fungible tokens to represent ownership, it presumably becomes possible to fractionalise (share) the ownership of any piece of art. Still, at the moment it remains unclear in which manner the execution of partial ownership rights thus emerging is supposed to look like (except in cases of a purely speculative activity). One can imagine associated mechanisms of royalty collection attached to every on-line viewing or token ownership transfer as an area in which the NFT infrastructure could be valuable. Nonetheless, there emerge multiple legal issues (such as custody, claiming, control and, last but not least, taxation) that apparently make engagement of official (and hence central) authority unavoidable. However, such an engagement would severely dilute the original vision of purely decentralised "on-chain ownership."

Both creating and transacting NFTs is expensive and lengthy. The reason can be found in the blockchain (mainly Ethereum) performance and scalability limits (e.g. minting an NFT can cost as little as $3 and as much as $500, depending on the momentary chain congestion, whereas transacting one is even costlier than minting, see https://www.ulam.io/blog/how-expensive-is-nft-minting). Therefore, the mass transfer of titles to cheap items on-chain is hardly an attractive proposition. Only expensive infrequently transacted objects justify tokenisation. Another problem is the storage of NFT-underlying data: keeping them in their entirety on Ethereum requires a lot of gas, whereas storing off-chain is vulnerable to both technical incidents and malicious attacks. And, as usual, the legal protection of property rights cannot be arranged on the underlying chain itself and requires an authority willing to accept Ethereum (or another smart contract-enabling blockchain) records as sufficient property titles. But, an authority willing to accept the legal validity of a blockchain will also want (actually, be obliged) to regulate it, thus putting an end to the anarcho-capitalist dreams popular among blockchain fans.

Permissioned and hybrid blockchain applications, existing and prospective

One area in which, by offering a solution to the traceability problem, smart contract-hosting blockchains have a clear potential to enhance market integrity and efficiency is the trade in gems. For traded jewelry articles, they can provide transparency and verification to both the regulators, e.g. with regard to compliance and KYC procedures, and other users who require it, while still preserving the privacy and specific views of the ledger that are relevant for different types of user (Cartier, 2019). This is why blockchain is being widely investigated as a promising technology in the gem industry. For example, in 2017, diamond miner De Beers launched the Tracr blockchain to track diamonds through the full value chain. Further, there has emerged the blockchain-based Trustchain Initiative (piloted by IBM), an industry collaboration pursuing traceability in diamond and gold jewelry from mine to retailer. Finally, Gübelin and Everledger have been piloting (starting in 2019) a blockchain for coloured gemstones. Apparently, the chains being explored are private ones, with a clearly identifiable responsibility of the operator.

In banking and finance, blockchains are being gradually tried out in a number of areas beyond the exchange of digital currencies. The tokenisation discussed above is just one of many approaches that are being investigated as avenues towards more efficient primary and secondary markets for financial and non-financial products. Many in the financial industry believe that, soon, investment portfolio holdings may include interest in a diversified blue-chip art fund, a jewelry collection, or carbon credits. Some other business areas into which blockchain has recently made inroads include: trade finance, cross-border payments (see more in Derviz, 2023), clearing, settlement and other post-trade infrastructure (e.g. automation of middle and back office settlement processes), and real estate. In the latter area, records, investment, transactions, escrow services, etc. are being put on-chain above all for commercial and high-end residential property (Pandya, 2024).

In big multinational supply networks, distributed ledgers are seen as a way to ensure end-to-end visibility and traceability. By recording every step of a product's journey on the blockchain, from raw materials to manufacturing, shipping, and delivery, companies can ensure authenticity, reduce fraud, and optimise the supply chain's efficiency. For example, Walmart uses a blockchain to enable its employees to scan the goods in the store's app and then track them from the harvesting stage to the time it reaches the store floor. On the other hand, Makers use the technology to monitor cargo ships. All these are chain examples with access restricted to trading parties.

Blockchain technologies promise to help in medical data management and medical supply tracking. This would benefit both patient care and medical research, and quite importantly, ensure the authenticity of drugs circulating in global markets. The World Health Organization has estimated that one out of ten medical products that are offered in the low or medium income countries are not just sub-standard but outright falsified. A decentralised immutable publicly accessible database of medical drugs would be able to lower the instances of pharma fraud. An example is a smartphone app Verifier that uses the phone's camera to conduct a spectral analysis on the drug and loads it on its blockchain for verification of the drug's medical footprint.

As regards treatment, blockchain is expected to guarantee patient privacy without jeopardising (or rather, enhancing) interoperability. So far, all attempts at systems of data sharing between healthcare providers, when entrusted to a central agency, have made limited progress, despite the general understanding that such sharing would lead to more accurate diagnoses and personalised treatments. Therefore, the vision of breaking this spell is associated with encrypted medical records on-chain owned by the patient and accessible only to authorised personnel. Here, the involved blockchains would be private and permissioned, desirably with the patient's (i.e. the ultimate data owner's) rights secured by construction.

Proposals and pilot projects of blockchain use abound in many burgeoning segments of the P2P economy. Indeed, this is an environment in which, on the one hand, decentralisation is the cornerstone of the operation, but, on the other, there exists a rich history of disputes between users, providers and agencies that intermediate the corresponding business. Therefore, immutable and easily verifiable records are of particular value. Accordingly, blockchain-based initiatives have appeared in the ride-sharing economy (Arcade City, https://cointelegraph.com/tags/arcade-city), microloans (exact record of the lending process from application to disbursement: Twigga, https://kenyanwallstreet.com/twiga-foods-to-offer-blockchain-based-microloans-to-food-kiosk-owners-in-kenya/), and advertising, particularly affiliate marketing (evidence of targeted recipients on a social network, visitor origin verification). Another area in which the same issues are expected to rise in the nearest future is direct trade between small independent power generation units (including the solar panel production of households), put on the same footing with larger state and national networks. It was announced in 2022 that the China Energy Administration was investigating the use of such platforms. However, the cost of on-chain energy trading, as well as implications for price stability, is still a matter of debate.

Blockchain is also advertised as a means to enhance the security of mobile apps and the Internet of Things (IoT). In this area, the vulnerability of the connected devices to glitches and hacker attacks comes as the flip side of user comfort. Presumably, a blockchain infused into the IoT ecosystem would simplify troubleshooting and attacker identification thanks to immutable use history and the available chain analysis. Similar hopes are being associated with future blockchain-powered ex-post analyses of chatbot communication, once the latter becomes sufficiently widespread.

Conclusion: experiences and challenges

Whereas the original blockchain creators were hostile to central administrators as a matter of principle, the subsequently developed applications of the technology, the examples of which were the topic of this article, are gradually returning many elements of centrality through a back door. To begin with, as blockchain networks grow, scalability becomes a significant challenge. Current public blockchains face considerable limitations on the number of processed transactions per time unit. At present, the task of overcoming scalability issues seems to be better tackled in private chains than the best known public ones. The Holy Grail of fully decentralised networks of sovereign individuals ruling over their economic life on-chain without intermediaries is therewith slipping out of reach. Another frequently overlooked pre-requisite of mass blockchain adoption is the balance between the constantly evolving requirements on user competence dictated by ongoing innovations, and consumer protection. Although authorities responsible for the latter are trying to adapt existing regulatory frameworks to the blockchain's borderless decentralised universe, legal accountability in this environment remains a conundrum. Until a generally accepted solution to the problem emerges, regulatory uncertainty around blockchain use will persist.

Benefits that come attached to the use cases of blockchain technology at large seem to have most appeal in areas grappling with two big categories of problems: security threats and a lack of transparency. In both cases, the cryptographic side of blockchain operation is the most important, as the previously mentioned product origin applications demonstrate. Still, when the virtual blockchain universe meets the real world, the confrontation of high-flying visions of blockchain enthusiasts with the abilities of alternative, including legacy, technologies makes several most-advertised blockchain advantages somewhat fade, even if not disappear completely. The outcome of the said confrontation is far from decided at the moment. Nevertheless, one emerging pattern becomes increasingly clear: the most sustained demand for blockchain solutions does not come from multitudes of users living the dream of "online democracy" and other anti-authoritarian visions, but from well-off owners of scarce objects of high value. But, such owners are better used to putting authorities to work to protect their interests than to attempting to make their officials unemployed.

Autor is Alexis Derviz. The views expressed in this article are those of the author and do not necessarily reflect the official position of the Czech National Bank. All errors and omissions are the author's responsibility.

References

Bang-Jensen, Jorgen (2008), "2.1 Acyclic Digraphs", Digraphs: Theory, Algorithms and Applications, Springer Monographs in Mathematics (2nd ed.), Springer-Verlag, pp. 32-34, ISBN 978-1-84800-997-4.

Cartier, L.E. (2019) Traceability and Blockchain for Gemstones - an Overview. Facette 25 (February) 6-8, https://www.ssef.ch/wp-content/uploads/2019/02/facette-2019.pdf.

Chatterjee, S. (2024) Top 4 Types of Blockchain: Revolutionizing the Finance Industry. Emeritus (January) https://emeritus.org/blog/types-of-blockchain/.

Derviz, A. (2023) Cross-border payments at a crossroads between SWIFT and DLT. Czecj National Bank, Global Economic Outlook (June), 13-17; https://www.cnb.cz/export/sites/cnb/en/monetary-policy/.galleries/geo/geo_2023/gev_2023_06_en.pdf.

Investopedia (2023) Hyperledger Fabric: Definition, Example, Risks and 2.0 Version (August) https://www.investopedia.com/terms/h/hyperledger-fabric.asp.

Jungnickel, Dieter (2012), Graphs, Networks and Algorithms, Algorithms and Computation in Mathematics, vol. 5, Springer, pp. 92-93, ISBN 978-3-642-32278-5.

Nuseibeh, R.M. (2023) Blockchain as a Service (BaaS): What You Need to Know. https://www.linkedin.com/pulse/blockchain-service-baas-what-you-need-know-rajai-m-nuseibeh/.

Pandya, Y. (2024) NFTs in Real Estate, How is Blockchain Disrupting Property Transactions and Ownership? https://medium.com/coinmonks/nfts-in-real-estate-how-is-blockchain-disrupting-property-transactions-and-ownership-9835c8b6b2b5.

Sharma, R. (2024) Non-Fungible Token (NFT): What It Means and How It Works. https://www.investopedia.com/non-fungible-tokens-nft-5115211 (January).

Keywords
DLT, blockchain

JEL Classification
E58, F31, F41

^[1] Despite a visible saturation in the subsequent year, the growth of venture capital investment in blockchain start-ups between 2020-2022 (Figure 2) testifies of the sudden surge in the investor interest in the area, precisely due to the widening application scope.

Public link

Please use the above public link if you want to share this noodl on another website.