By Scott Farrell
On early June, CSIRO’s Data61 published two reports on the scientific findings of Australia’s leading digital research network into distributed ledger technology (including blockchain). The result of many months of scientific study, the reports distinguish themselves from the recent collection of reports, reviews and releases by addressing not only the technical risks and opportunities in the application of blockchain technologies within government and industry, but how to assess whether blockchain-based systems will meet critical requirements and also the plausible future impact, opportunities and challenges of the technology.
In this article, we do not explain what blockchain or smart contracts are. We set 10 points below, including some of our observations. However, there is much more in the reports than we could hope to set out in this article.
Twin reports, one for now and one for the future
In May 2016, it was announced that Data61, the digital research-focussed part of Australia’s national science agency (CSIRO), would undertake a scientific study into blockchain in collaboration with other Australian Government agencies such as the Australian Treasury (see announcement here). The research was funded by the Australian Government’s National Innovation Science Agenda. The two Data61 reports are the results of that research:
- Risks and Opportunities for Systems using Blockchain and Smart Contracts. [PDF 1mb] This report aims to provide a better understanding of the technical risks and opportunities of blockchain technologies, through an examination of high-level design alternatives for a variety of representative use cases. It includes the selection of three representative use cases, an elaboration of some of their high-level requirements, the creation of solution architectures for them and the development of laboratory-based ‘proof of concepts’ for some of their design elements.
- Distributed Ledgers: Scenarios for the Australian economy over the coming decades. [PDF 2mb] This contains analysis, interpretation and foresight in order to inform government, industry and the broader Australian community of the plausible implications of distributed ledger technology. It uses four plausible scenarios to provide policy makers with a greater appreciation and depth of understanding of emerging issues likely to impact Australian business, industry and the economy, in addition to identifying and illustrating potentially significantly disruptive or high value use cases to relevant industries, sectors and communities.
The reports complement each other and in this Alert, we refer to the findings of each report together, as the study. Also, for simplicity, in this Alert we refer to blockchain generically to include distributed ledger technologies, as the term blockchain is more widely known.
Use cases selected, and tested
The study describes more than 20 different potential use cases for blockchain, in financial services, government services and enterprise and industry. From these, the following three are selected for analysis:
- an agricultural supply chain which uses blockchain to record events from various participants on ‘neutral ground’ in order to improve visibility and efficiency and to track provenance. The two blockchain designs tested are tracking the events on a blockchain, and also implementing the supply chain processes on a blockchain as a smart contract. A finding is made that “supply chains are a highly promising area for the application of blockchain technologies”. This is because blockchain helps integrate the disparate participants and the integrity of the ledger improves transparency and confidence. Also, the visibility and data integrity which can arise from blockchain’s use in supply chains can provide derived benefits, such as enabling trade finance and insurance applications.
- an open registry of government data, which uses blockchain to improve access to facilitate interoperation with registries of commercial data. The two blockchain designs tested were a data registry on a consortium blockchain across data providers and a data registry on a public blockchain. The study focusses on open data registry of data sets, data sources and data analytics services, so that confidentiality or privacy issues are not considered. A finding is made that a blockchain of open data could provide neutral ground to federate references to all of the open data sets, including as an index to the data which is maintained in their source repositories.
- an international remittance payment system, which uses blockchain to increase payment efficiency. The two blockchain designs tested were payments through a blockchain and Know Your Client (KYC) through a blockchain. The study notes that there can be many parties involved in the chain of transactions and there is sometimes little transparency on the total cost of exchange rates and fees. Further, complex regulation can be involved.
For each of these, the study considers the functional aspects, and non-functional aspects such the scalability, interoperability, latency, integrity transparency and cost issues.
This analysis is worth a careful read, not only for business which are connected with any of these processes (as user or supplier) but also for those connected to analogous uses, involving paper-dependent processes, stores of information or payments of value.
Future scenarios imagined, and considered
The study sets out four possible scenarios of an Australian future in 2030 with the purpose of working out implications for present day decision making around blockchain. The study is not predicting that these will occur, instead it uses them to identify potential blind spots, and to challenge assumptions and orthodoxies, so as to identify emerging opportunities and risks:
- Aspiration – regulations on rails. This scenario imagines a future where governments and the public sector have recognised the risks and potential of emerging technologies and provided leadership by embracing a cohesive regulatory regime.
- Transformation – sheriff on the digital superhighway. This scenario imagines a future where industry adopts a leadership role in the adoption of internet of things and blockchain technology, where industry standards and blockchain technology are used to manage the cyber security and data provenance problems.
- New equilibrium – a bumpy ride. This scenario imagines a future where the actions of the market are unregulated and there is no leadership or industry guidelines or standards. Blockchains proliferate and compete with each other and more traditional financial products.
- Collapse – a slippery slope. This scenario imagines a future where the worst of outcomes that could occur, happens. The failures stem from the combination of technological and regulatory issues that have led to an abandonment of the blockchain brand.
The analysis of potential causes, and outcomes, for each of these scenarios is conducted in depth, as is the commentary on issues relating to law and regulation, innovation, quality control, user adoption, interoperability and digital currencies. In the context of the scenarios, the study notes the possibility of blockchain being involved in creating programmable money and improving consumer welfare, in managing the provenance of a tsunami of data, improving other technologies with which it competes, a bewildering array of consumer products and the exacerbation of global economic risks.
In a business or enterprise sense, this analysis provides a much needed “over-the-horizon” glimpse on what a data driven economy might look like in less than 15 years time, and what can be done now to use blockchain technology to prepare for it.
Trust, trusted and trustworthy
The study identifies the key advance from blockchain technology as being distributed trust – removing the need to rely on a specific single trusted third party (or small number of specific trusted third parties) to facilitate transactions. This core benefit arises through blockchain’s capability for it to establish a fact at a given point of time, which can then be trusted. It does this through automating the three roles of the trusted third party: validating and safeguarding transactions, and then preserving them. This provides a distinctive opportunity when either a specific trusted third-party is unknown or not sufficiently trustworthy, or when they are extracting fees that are high in relation to the transaction value.
The study states that in economies where trusted third-parties are not always trustworthy, a significant benefit of blockchain systems may be in the strong support they can provide for immutability and non-repudiation. In developed societies, trusted third-party organisations are usually trustworthy, so the benefits of using blockchain technologies would likely arise from enabling faster business model innovation, reducing the cost of establishing business relationships, and perhaps reducing the cost or risk of transactions. In this context, in addition to the use cases mentioned above, the research notes payments, escrow, notarisation, citing, registration and process coordination services can be supported by blockchain transactions, and also notes that conventionally these services are provided by specific trusted third-parties such as banks, legal firms, accountancy firms, government agencies, and service providers in specific industries.
Also, the study reflects on the importance of the application of trust in the context of internet-based global trade and commerce. This has a network architecture that was designed for resilience and high availability with limited functions for ensuring accuracy and secrecy. Accordingly, information security controls have had to be ‘bolted on’. The trust-generation which blockchain provides can respond to this and contribute to the health and hygiene of our digital infrastructure.
Understanding its connection to trust is critical to understanding blockchain and its potential. As trust is a fundamental part of many businesses, these aspects of the report are likely to be carefully read by those keen to improve, or defend, their strategic position.
Recipe for a good blockchain
The study considers what adds up to a good blockchain from a number of different perspectives. It finds that drivers which are likely to be important in using it as a good technical design choice are:
- multi-party processes across organisations or industries.
- a need for greater transparency, provenance and vision of transaction history.
- a desire to reduce cost and inconsistency from redundant data.
- a need to provide better ways of sharing data between stakeholders.
- a need for improved and more flexible ways of supporting data integrity and access control.
- business opportunities arising from inefficiencies, cost or impediments to innovation within current systems.
From a technical perspective, the successful operation of a blockchain system relies on several key elements, including:
- appropriate integrity criteria to be checked for each transaction (and block);
- the correctness of the system’s software and technical protocols;
- strong cryptographic mechanisms to identify parties and check their authority to add new transactions; and
- a suite of incentive mechanisms to motivate processing nodes to participate in the community and to behave honestly, in its interests.
Further, in assessing the viability of a potential blockchain solution the study suggests the following be considered:
- the volume of transactions will increase, and this might require significant transaction record keeping changes.
- a blockchain does not need to dis-intermediate in order to generate value. Its ability to reduce friction extends beyond this, and can reduce transaction time and cost, and improve fraud and corruption control.
- a blockchain does not need to have a crypto-currency, other consensus methods and governance structures exist and are being developed.
- blockchains may provide value as a fraud-resistant and tamper-evident record, which can provide active surveillance and counter-measures to a number of economic crimes.
- the persistence and immutability of the information kept on the blockchain (for example, from a privacy perspective, or if a participant ceases to be part of the system).
These findings, particularly because they are based on independent scientific analysis, should be particularly welcomed by enterprises and agencies who are considering adoption of the technology. Importantly, they refer to factors beyond the technology itself. Some of our further thoughts on this can be found here.
Useful, but not so smart, contracts
The study notes that “smart contracts”, or computer programs which can be stored and execute as part of the transactions on a blockchain, significantly expand the power of blockchain systems, and increase the range of use and potential for innovation. The finding is made that they could enable new kinds of “programmable money”, meaning that parties could attach policies on how parcels of money are spent or transferred, which would be self enforced on a blockchain as smart contracts. However, the study notes that the name ‘smart contracts’ is often not suited as it is typically not ‘smart’, and is not used to execute or monitor legal contracts. The terms ‘automated contract tools’ or ‘automated transaction tools’ may lend themselves to less confusion.
Despite recognising that smart contracts are not always legal contracts, the study does note that interoperability with law is an important factor. It notes that smart contracts do need to exist within a legal framework that links the code to the contract. Further, whilst software is global, the law is not and that, as a result, complex legal questions may occur when executing smart contracts across multiple jurisdictions.
This is a fundamental issue for the use of smart contracts in the “real” world. As the law is the “code” of real world society and economy, it is critical that interoperability between law and technology exist. Please see here for some of our further thoughts on this.
- Risk reduction. The study notes that, compared to conventional centralised databases and computational platforms (on-premises or cloud), blockchains can reduce some counterparty and operational risks by providing ‘neutral ground’ between organisations. Also, the technology may provide advantages for integrity and non-repudiation.
- Confidentiality. The study makes a number of comments relating to the confidentiality of the data. It notes that privacy and confidentiality are hard to establish on a public blockchain, because any member of the public can obtain a full copy of the whole transaction history and use it without restriction. It notes whilst this can be managed within pemissioned or private blockchains there may be an ability to discover information shared between participants that is normally held commercial-in-confidence. Further, the report notes the potential impact of increasing computer power on encryption standards. As blockchain records persist, if their encryption is not enhanced over time then they will need to contend with computers more powerful than those in existence when they were first created.
- Permanence. The report notes that the permanence and persistence of data kept on a blockchain creates issues, as well as solving problems through its integrity and auditability. These issues include the expanding size of the blockchain if too much data is required to be maintained on it, and the inability to remove data from the blockchain if it becomes necessary for other reasons, such as due to a court order or operation of laws.
From a non-technical design perspective, data-related issues are one of the most critical to consider carefully and they can drive a number of design-related decisions. The commentary of the study on these provides valuable guidance for those trying to understand how they might use the technology. Consideration of this is timely, given the discussions currently underway on open data, see here for more information.
Who and how much, digitally
Two of the most discussed topics in relation to blockchain are its use with digital identity and digital currency. The study speaks to each:
- Digital identity. The study notes that digital identity is verging on a human right. It points out that, if they are designed well, distributed ledgers have the potential to provide answers to identity-based questions that do not present a privacy risk. This is through holding and selectively sharing verified claims for attributes of an identity, along with the provenance of the verification or source document. The study also finds that identity is sometimes considered to be a key enabler for many financial services on blockchain. It finds that digital identity management presents the benefits of bolstering trust and certainty for economic activity but poses challenges in terms of privacy and security. The study also notes that significant digital infrastructure enabling digital identity management could be considered a national asset, and a competitive advantage. Research into the policy and technology options would inform regulators and industry of ways to balance the related risks and rewards.
- Digital currency. The study finds that a crypto-currency is not necessary for a blockchain to be effective. However, particularly as the technology was originally developed for this purpose, this use is considered, and contrasted with other uses. The report does extend its consideration further into sovereign digital currencies but notes that the benefits, risks and uses of sovereign digital currencies are not yet well understood, although several countries have and are considering this potential. Along these lines, it is noted that it is possible that if one jurisdiction were to introduce a sovereign digital currency, then others may follow suit.
These two areas present tremendously powerful possibilities for a digitally enhanced future, for example by providing greater control over access to one’s own data and enabling commerce on a purely digital platform. However, as the study notes, there are complex issues to consider and this is an area deserving of further research.
The importance of regulation in navigating a future with blockchain resonates throughout the study. For example, recommendations are made that regulation and policy should be technologically neutral, guidance on sufficient evidence for regulatory acceptance should be made available and technology-specific risks for new blockchain systems should be scrutinised. However, a key differentiator between the future scenarios considered in the study is the level of engagement and response of regulation to the use of the technology. Those scenarios show an extensive difference in outcomes influenced by different regulatory approaches.
This should give many in both the private and public sector food for thought. See here for information on the guidelines recently released by the Australian Securities and Investments Commission in relation to the use of blockchain in connection with financial services.
Beyond blockchain myths
As the result of scientific analysis, the study dispels a number of blockchain myths. For example, the myths that blockchain solves every problem (it doesn’t), it removes trust (you still need to trust the system and the inputs into it), it is always totally secure (encryption is often needed, and sometimes data needs to be held separately), it is always immutable (that depends on the consensus mechanism) and that it can’t scale (current restrictions on size and speed could change with new developments). Importantly, the myth that a blockchain is the entire solution to a problem is also contradicted. The study finds that a blockchain system needs to work with other systems, including other blockchain systems. This requires interoperability standards to be developed (like those being developed by the International Standards Organisation, see here for more on these).
Along this line of requiring interoperability, the study also describes how the use of blockchain is more than an IT issue. In fact, it finds that developing blockchain applications requires more than IT expertise, due to the need to consider the impacts in the real world. It is noted that this requires an awareness and appreciation for many of the non-technical fields, such as accounting, audit, fraud, law, banking and finance and any relevant sector in which the blockchain operates. Accordingly, the study notes, professionals and practitioners from many disciplines would be required to be engaged in order to balance risk and optimise reward.
The study reserves some of its clearest “myth-busting” for those which are taken from Bitcoin. It notes that blockchains do not need to have the governance, and energy consumption issues, which arise from the Bitcoin system if they adopt a different governance structure. In fact, the study finds that that it is counter-productive to centre on Bitcoin in considering blockchain as it represents a very specific use case.
The study’s findings in this regard are very helpful to those designing or considering the use of a blockchain and they clarify where aspects of the first use of blockchain (Bitcoin) do not need to be carried into new generations of the technology.
Is that it, finally?
No. We have only scratched the surface of the study in this article. The two reports comprising the study are thorough and packed with information. They warrant a careful read by those who are serious, or just wondering, about the use of the technology in the public or private sector. This report provides guidance and assistance for those who need to know what they don’t know before engaging more deeply with this transformational technology. Critically, for those considering the technology from either a tactical or strategic perspective, the reports provide a scientific foundation for making decisions not only on what the technology is and what it can do, but where it might lead us and how we might get there.
If you need further guidance on what CSIRO Data61’s Blockchain study means for you, please contact us – we are happy to help.
Scott Farrell is named as a contributor to the study in the reports. However, this article is written for King & Wood Mallesons and should not be taken to be connected to Data61. Further, this article should not be taken to be connected to Scott’s role on the Australian Government’s FinTech Advisory Group.