What Are Blockchains For?

A blockchain is a technology to implement a shared ledger that is guaranteed to be correct and unchangeable. But what are blockchains for? When do you need such a thing? Why not use a traditional database? Databases can store transactions and they can be shared. Database technology is mature and can achieve high transaction volumes. Blockchain technology, by contrast, is still in its infancy stage and problems include low throughput and high latency. Why should we move to an immature technology?

Let’s ignore for the moment the technical problems that still plague blockchain technology and simply assume that the technology will mature just as database technology has done. We can then focus on what really matters, namely what databases and blockchains can be used for.

Blockchains are used to support coordination.

A very general answer is: They are used to coordinate the activities of people and organizations. Employees coordinate their activities by interacting with a shared database. Companies in a value chain coordinate their activities by sharing relevant information across company boundaries. Traders in a stock market coordinate their activities using databases with real-time transaction information.

How should we then make the choice between databases and blockchain? To answer this question we should look at what databases and blockchains are used for: to coordinate the activities of people and organizations. In general, coordination is the management of dependent activities by different actors, and information technology is used to support this.^[1]T.W. Malone and K. Crowston. The interdisciplinary study of coordination. ACM Computing Surveys, 26(1), 1994. The idea is elaborated in Wieringa, R. J. Information Technology as Coordination … Continue reading

Social scientists distinguish three types of coordination: Hierarchies, markets, and networks.^[2]W.W. Powell. Neither market nor hierarchy: Network forms of organization. Research in Organizational Behavior, 12:295-336, 1990. In practice these forms of coordination may be combined depending on the needs of stakeholders, but it is useful to describe them as if they occurred in their pure form.

Hierarchies

Hierarchies are organizations with a management hierarchy defined by accountability and reporting relations. Employees report to their manager, who is accountable for the results produced by the employees. Databases have been developed for these kinds of organizations. There is a database administrator who identifies users and defines roles and access permissions for them. Users are trusted to perform their roles reliably but there are procedures for backup and recovery should something go wrong. Coordination takes place by management hierarchy and is supported by the database. Managers and employees are known and trusted. There is no reason, in this case, to move to blockchain.

Markets

At the other extreme is a so-called discrete market, in which participants can remain anonymous and coordinate their activities in discrete transactions that are fully specified. Examples are spot markets, the stock exchange, and auctions. Coordination is not by management authority, but by price alone. Transactions are reciprocal in the sense that buyer and seller both profit from them. In discrete markets, participants are anonymous, and so it is unknown whether they can be trusted. Accountability is realized by specifying complete contracts, in which all contingencies are specified and dealt with.

IT support for these markets uses databases managed by trusted third parties to manage the problem of anonymity and lack of trust. This requires the trusted third party (TTP) to be online always, and be ready to receive proposed transactions. These are validated by the TTP and cleared transactions are entered in the database. This solution makes the market look like a hierarchy with dominant stakeholders who clear transactions.

Non-permissioned blockchains are an alternative to the database solution that is better geared to the goal of a discrete market. They provide pseudonymity (every participant can choose as many pseudonyms as they want) and by their consensus mechanism practically guarantee that the ledger of transactions can be trusted, even though the trustworthiness of the participants is unknown. And by allowing read access to anyone, all stakeholders can independently verify the correctness of the transactions in the ledger.

Networks

The third kind of coordination is the network, in which a group of stakeholders with a shared interest coordinate their activities. This may be a group of neighbors trading surplus electricity with each other or sharing a pool of cars, or companies in a value chain who want to provide traceability of the components of a product. There is no management hierarchy and price is not the coordination mechanism. Rather, the participants of the network coordinate their activities by shared norms. The coordinated activities are a shared burden, and benefits produced jointly by the network are shared as well without being allocated in a measured way to participants. Accountability is a joint responsibility.

If IT support is provided by a database, there will be a TTP who manages a database of transactions and also acts as a gatekeeper who manages entry and exit of participants of the network. Participants are known and they are trusted to abide by the shared norms of the network, so they can enter transactions directly in the database. They must all trust the TTP to manage the database correctly, to keep it confidential, and to take care of backup and recovery.

Here, permissioned blockchains are a good alternative that avoids the use of a TTP. Participants are known and can enter transactions directly in the blockchain. The consensus mechanisms practically guarantee that transactions are valid and the transparency of the blockchain to all ensures that all stakeholder can check the integrity of the data. Replication of the blockchain over nodes of the network ensures that the data will not get lost. In contrast to non-permissioned blockchains, there is an element of hierarchy because there is a gatekeeper who identifies and assesses candidate participants in the network. This is in line with the assumption of shared norms of the participants of the network.

Value models

The success of a blockchain implementation depends on the needs of the stakeholders who use it, and these needs are to a large extent determined by the way they wish to coordinate their activities. To assess the chance of success as early as possible, these coordination mechanisms must be modelled as early as possible. E³value has been developed to model value webs that function as markets or networks. Transactions are reciprocal, and one of the returns of a service delivery can be norm compliance. Modeling a value web by e³value thus forces one to make coordination by price or norm compliance explicit and this allows early assessment of the suitability of blockchain as IT support for the value web.

Questions? Contact us at info@thevalueengineers.nl.