Julius Baer Research & Investment Solutions | Please find important legal information at the end of this document. RESEARCH FOCUS | FRIDAY, 7 APRIL 2017, 10:26 CET 1/25 NEXT GENERATION BLOCKCHAIN THE MISSING PIECE OF THE INTERNET A NEXT GENERATION BRIEFING • Following substantial interest in recent months, and the immense amount of ‘hype’ around the topic in 2016, we present our briefing on the potential of blockchain and the key underpinnings of the technology. • Blockchain technology — also known as distributed or shared ledger technology (‘DLT’ or ‘SLT’) — encom- passes protocols which form the basis for distributed, encrypted, and theoretically ‘tamper-proof’ ledgers. • The basis for today’s blockchain technology was first deployed in 2009 with the initiation of Bitcoin — the world’s first decentralised, peer-to-peer cryptocurrency. • Though blockchain and Bitcoin emerged together, the latter is but one of the possible uses of the former — blockchain is an architecture, not an application. • The many potential use cases range from revolutionis- ing the post-trade infrastructure in capital markets, to providing tamper-proof electoral systems. • While we reckon adoption will eventually be substantial due to the technology’s cost, speed and risk manage- ment advantages, the timeframe, degree and fields of adoption remain very challenging to determine. • Our base case is, however, that blockchain will have far- reaching consequences for industry and employment, no matter whether adoption is incremental or disruptive. • Nonetheless, direct equity exposure remains elusive. Alberto Perucchini +41 (0)58 88 62055, [email protected]DIGITAL DISRUPTION The phenomenon of digitalisation, led by the proliferation of computing power and greater internet connectivity, is affecting every corner of our lives. Importantly, digitalisa- tion is not only transforming the way we consume data and work, but also how people interact. CONTENTS What is blockchain technology? p. 2 The range of use cases for blockchains p. 10 Investment conclusion: Beyond hype, but early days p. 18 Postscript: Interview with Dr. Garrick Hileman p. 19 fdf EXECUTIVE SUMMARY It is not a question of ‘if’, but ‘when’, ‘where’ and ‘how’ blockchain technology will be implemented in industries, such as finance and trade, which deal with the storage and exchange of trusted information and value. With quicker transaction settlement times and lower resource intensity than traditional ledgers, blockchains have the potential to revolutionise how business networks operate. The technology allows the development of protocols which form the basis for distributed, immutable and tam- per-proof ledgers. These can be designed with additional properties which open up a myriad of possibilities, such as ‘cryptocurrencies’ (including the famous ‘Bitcoin’), ‘smart contracts’, and the digitalisation (also known as ‘tokenisa- tion’) of real-world financial and physical assets. Based on these properties, blockchain is poised to stream- line, rationalise and digitalise payments settlement and the post-trade infrastructure in capital markets; revolu- tionise trade finance; and cut financial institutions’ back- office costs. We recommend that investors avoid firms with high exposure to custody and registry activities, as well as correspondent banks and traditional cross-border payments systems operators. Firms which provide back- office outsourcing and software are also likely to suffer. Finally, we recommend investors avoid taking any long- term positions in any permissionless cryptocurrency (such as Bitcoin), due to poor governance and volatile adoption. ddd
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Julius Baer Research & Investment Solutions | Please find important legal information at the end of this document.
RESEARCH FOCUS | FRIDAY, 7 APRIL 2017, 10:26 CET 1/25
NEXT GENERATION
BLOCKCHAIN THE MISSING PIECE OF THE INTERNET
A NEXT GENERATION BRIEFING
• Following substantial interest in recent months, and the
immense amount of ‘hype’ around the topic in 2016, we
present our briefing on the potential of blockchain and
the key underpinnings of the technology.
• Blockchain technology — also known as distributed or
shared ledger technology (‘DLT’ or ‘SLT’) — encom-
passes protocols which form the basis for distributed,
encrypted, and theoretically ‘tamper-proof’ ledgers.
• The basis for today’s blockchain technology was first
deployed in 2009 with the initiation of Bitcoin — the
world’s first decentralised, peer-to-peer cryptocurrency.
• Though blockchain and Bitcoin emerged together, the
latter is but one of the possible uses of the former —
blockchain is an architecture, not an application.
• The many potential use cases range from revolutionis-
ing the post-trade infrastructure in capital markets, to
providing tamper-proof electoral systems.
• While we reckon adoption will eventually be substantial
due to the technology’s cost, speed and risk manage-
ment advantages, the timeframe, degree and fields of
adoption remain very challenging to determine.
• Our base case is, however, that blockchain will have far-
reaching consequences for industry and employment,
no matter whether adoption is incremental or disruptive.
• Nonetheless, direct equity exposure remains elusive.
or trusted information (such as identity or ownership) over
the internet is not as straightforward as exchanging or
retrieving songs, e-books or video-on-demand online.
When one wishes to modify or exchange value online, one
generally has to go through stringent identification and
validation procedures, with most steps often still taking
place offline rather than online. More importantly, a trust-
ed central authority (or a series thereof) is required to
inspect, validate, clear and settle digital modifications and
exchanges of trusted information and assets.
Trust deficit can be resolved through technology
The fundamental issue is one of trust — or rather the lack
of it. It is the core hurdle impeding the frictionless transfer
of value over digital channels. Indeed, if value
exchanges or modifications were seamless and instanta-
neous, how could the proper verifications be carried out?
At a high enough processing speed, for instance, a mali-
cious party could sell or send two or more of a given asset
to two different counterparties, despite owning just one —
an instance of the so-called ‘double-spend problem’.
Blockchain technology, and its first and most widely-
known application (the cryptocurrency known as ‘Bitcoin’,
initiated in 2009), emerged precisely as a response to the
double-spend problem. It offers concepts and mecha-
nisms — derived from cryptography, economics, mathe-
matics and network theory — which seek to embed trust
into a protocol, to which all participants in a business net-
work can agree, in order to modify and exchange value.
Technology, not law, thus becomes the source of trust
between participants, enabling the digital notarisation of
information and exchange — and the Internet of Value.
By contrast, in a ‘classical’ (i.e. non-blockchain) set-up, in
which laws and regulations are the primary source of trust
for network participants, we see important failings
emerge. Their responses to the trust deficit and the dou-
ble-spend problem are comparatively inefficient.
The failings of classical ledgers
Ledgers are records of value: trusted information and/or
transactions (e.g. a record of bank transfers, or a registry
of real estate titles). In the classical case, participants in a
business network each hold their separate ledgers to keep
a record of value ownership and transfers at any given
time. For instance, in a nation’s banking system, each
bank will hold a record of asset ownership, as well as of
asset transfers with other banks. This is the classical case
illustrated in Figure 2 on the next page, in which each
participant in a business network holds its own ledger of
network transactions.
As you will note, a central authority is inevitably required
in the classical case, as business network participants
might (1) not trust each other, and (2) hold inconsistent
records across their respective ledgers. A trusted central
authority thus emerges as a consequence of holding mul-
tiple ledgers within the same business network. This cen-
tral authority performs reconciliation and risk manage-
ment on behalf of the participants. In most cases, this
trusted counterparty is recognised in laws and regulations
as the guarantor of trust within a given industry — say, a
central securities depository holding a permanent record
of which banks and banking clients own which securities.
NEXT GENERATION | BLOCKCHAIN: THE MISSING PIECE OF THE INTERNET | FRIDAY, 7 APRIL 2017, 10:26 CET 3/25
Figure 2: A business network with a classical ledger (i.e. non-blockchain) set-up
Source: International Business Machines (IBM) Corp., Julius Baer
Figure 3: A business network with a blockchain-based (i.e. distributed ledger) set-up
Source: IBM Corp., Julius Baer
This holds some evident downsides: the processes of reconciliation and risk management slow down the modification of
trusted information and the exchange of value, also making the processes more expensive and resource-intensive. Fur-
thermore, were a trusted central authority to be compromised or turn malicious, both censorship and fraud are a possi-
bility, as it could tamper with the records and processes of the business network.
The comparative advantages of blockchain set-ups
Blockchain-based (i.e. distributed or shared ledger) implementations, on the other hand, require neither a trusted cen-
tral authority, nor the holding of separate ledgers by network participants. Rather, a single ledger exists, with identical
NEXT GENERATION | BLOCKCHAIN: THE MISSING PIECE OF THE INTERNET | FRIDAY, 7 APRIL 2017, 10:26 CET 4/25
copies distributed among participants. Importantly, trust between participants is also not required. This blockchain set-
up is illustrated in Figure 3 above.
In the blockchain set-up case, participants need not waste resources or time validating modifications or transactions
with the support of a trusted central authority, which leads to gains in efficiency. Furthermore, and as we discuss below,
blockchain-based ledgers are theoretically both immutable and secure: they cannot be tampered with, and one cannot,
in theory, record fraudulent modifications or transactions onto them. How are these features enabled?
The technological foundations of blockchains
Blockchains are, ultimately, protocols which form the basis for the distributed ledger set-ups we have described above.
Their various properties emerge from their integrated technical design, which rests on the combination of three techno-
logical foundations, namely:
(1) Encryption and cryptographic tools: these ensure identification, validation and non-repudiation of identities
and operations on the ledger, as well as information integrity — various encryption methods are used, includ-
ing, famously, ‘public-key cryptography’;
(2) Consensus mechanisms: these are algorithms followed by network participants in order to determine whether
a ‘block’ of validated operations should be added to the network’s shared ledger (or ‘chain’), or rejected;
(3) Timestamps and ‘hashing’ of previous blocks: these ensure that each subsequent block on the chain in-
cludes an encrypted, consistent and immutable record of all previous blocks.
How these three pillars are concurrently used in order to generate working blockchains is both highly technical and quite
fascinating, though we will refrain here from examining the technicalities. We nonetheless provide a diagram of a gener-
ic blockchain’s workflow below (see Figure 4). Beyond technicalities, the key implication of the technologies employed
in a blockchain protocol is that they generate decentralised, trusted and immutable distributed ledgers. These distrib-
uted ledgers are called ‘blockchains’ since they consist in a self-consistent ‘chain of blocks’ created and agreed upon by
network participants, with each block containing an encrypted record of the most recent network-validated operations,
as well as of all the operations contained in all previous blocks.
Figure 4: The workflow of a generic blockchain protocol in four steps — from operation validation to ledger maintenance
Source: Julius Baer
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‘5—4—5’: A summary of blockchain’s capabilities
What specific characteristics and capabilities thus emerge
from blockchain designs? We find it useful to think of
blockchain’s capabilities in terms of a scheme we call
‘5—4—5’: 5 properties, 4 advantages and 5 additional de-
velopment dimensions (see Table 1).
Table 1: The ‘5—4—5’ scheme in table format
Source: Julius Baer
Let us first consider the five properties of blockchain
technology. As we will also see further below, the five ad-
ditional dimensions which can be developed around block-
chains can either undermine or enhance some of these
properties: we thus include ‘caveat notes’ for each below.
Properties of blockchain protocols
(1) Decentralisation
Blockchain solutions remove the ‘single point of
failure’ embodied in a compromisable, trusted
central authority; consensus about modifications
and transactions of value is reached in an envi-
ronment in which trust has been disintermediat-
ed, decentralised and distributed through a tech-
nological instrument (the consensus mechanism).
Caveat: Some elements of centralised control can
be re-established under certain blockchain archi-
tectures, for regulatory or commercial reasons.
(2) Immutability
Because each block in a distributed ledger’s chain
refers back cryptographically to the previous
blocks, records are permanent as long as the par-
ticipants who carry out the chain’s consensus
mechanism continue to maintain the network.
Caveat: Events called ‘forks’ can occur, in which a
supermajority of a blockchain’s network decides
to retroactively alter a blockchain’s records, or the
network splits into factions following ‘forking’
(two or more) protocols and chains. Likewise, a
more centrally-controlled blockchain may see its
administrator(s) alter past records if required.
(3) Transparency
Network participants (and, for some protocols,
the wider public) have visibility access on the pro-
cess of consensus formation on-chain, as well as
on the blockchain’s entire record — this enhances
business-friendliness (for some use cases), and
guarantees an audit trail and a trusted workflow.
Caveat: Transparency does not mean ‘privacy’
(quite the contrary, in most cases) — due to regu-
latory and commercial concerns, some blockchain
protocols can segregate visibility access depend-
ing on the network participant’s identity or rela-
tionships.
(4) Security
Because on-chain ‘addresses’ are cryptographical-
ly secure, and participants can place their trust in
the integrity and secure features of the consensus
mechanism, the integrity of identity, information
and modifications/exchanges is guaranteed.
Caveat: All consensus mechanisms need to allow
some degree of fault tolerance, and thus are sub-
ject to some attack formats (though much less so
than traditional ledgers). Underlying code may al-
so contain exploitable weaknesses. Furthermore,
the ‘identity problem’ remains an issue, whereby
the very security afforded by cryptographic ad-
dresses might lead to participants being locked
out from their own on-chain holdings and rights.
Finally, and as noted for property (3), security
and transparency combined do not necessarily
equate to privacy, as a cryptographic address on a
high-visibility access network could be conceiva-
bly tied to a real-world participant with enough
investigating.
(5) Efficiency
Blockchain set-ups have the potential to be sub-
stantially more efficient than classical ones, in ei-
ther settlement speed (near-instantaneous),
costs (for network and chain maintenance) or risk
management (trust generated by consensus algo-
rithm). Blockchain implementations can further
be borderless, ‘distance-neutral’, achieve perma-
NEXT GENERATION | BLOCKCHAIN: THE MISSING PIECE OF THE INTERNET | FRIDAY, 7 APRIL 2017, 10:26 CET 6/25
nent uptime and potentially create new revenue
streams (e.g. for on-chain data analysis services).
Caveat: Depending on the architecture of the
blockchain protocol and network in question (i.e.
type of consensus mechanism, degree of access
to the wider public, etc.), some implementations
might be slower or more resource-intensive than
their classical counterparts for some use cases.
Accordingly the four key advantages of blockchain-based
ledgers over classical ledgers emerge in property (5):
(1) Increased settlement speed;
(2) Reduced costs;
(3) Risk management efficiencies (i.e. balancing
trust, risk and efficiency);
(4) The potential to create new revenue streams
for participants/chain operators.
As alluded to above, both the properties and advantages
of blockchains can be enhanced or reduced, depending on
specific implementations. In fact, much of the work car-
ried out in ‘conventional’ industrial sectors (e.g. finance)
over the past years have centred around how to ‘tweak’
blockchain protocols to suit particular ends. It is thus cru-
cial for investors to grasp the five additional develop-
ment dimensions which have guided enhancements and
modifications to blockchain protocols’ core capabilities.
Additional development dimensions for blockchains
(1) Cryptocurrency
Cryptocurrencies (such as Bitcoin, the first cryp-
tocurrency) emerge from blockchain protocols
configured with specific consensus mechanism
implementations. Cryptocurrencies are on-chain
tokens (i.e. representations of ‘value’ on the
blockchain) which are ‘native’ to the ledger. In
other words, they do not represent any real-world,
off-chain asset (such as fiat currency or a finan-
cial/real asset), and derive their value directly
from their intrinsic supply and demand dynamics.
Traditionally, cryptocurrencies have been issued
as ‘reward tokens’ in the earliest-used blockchain
consensus mechanism, so-called ‘proof-of-work’
(PoW). Under this consensus mechanism, partici-
pants in the consensus process (nicknamed ‘min-
ers’) compete to solve a cryptographic puzzle,
which when solved enables the creation of a new
block. The winning miner is rewarded with native,
on-chain tokens (i.e. some cryptocurrency) in ex-
change for maintaining and updating the ledger
with their computing power.
This type of issuance is used in the case of
Bitcoin: bitcoins are awarded as compensation for
successful ‘mining’ of a new block. In other cases,
cryptocurrencies have been issued at initiation of
a blockchain network, in a fixed amount to all par-
ticipants (i.e. an initiation offering).
Chart 1: The six major cryptocurrencies as at 6 April 2017
Source: CoinMarketCap, Julius Baer; data as at 6 April 2017, 16:00 CET
More recently, ‘initial coin offerings’ (ICOs) and
‘additional coin offerings’ (ACOs) have been or-
ganised, in a clear parallel to public equity offer-
ings on traditional stock markets (see Chart 2 be-
low). Early participants in the network here buy
newly-issued tokens (or ‘coins’) with fiat currency
or another cryptocurrency, thus injecting value in-
to the new cryptocurrency, and providing an equi-
ty liquidation ‘exit’ for the developers of a new
protocol. This method of issuance has become in-
creasingly popular, and has to a certain extent re-
placed some venture capital and angel funding.
Chart 2: Total funds raised in token offerings, 2013–YTD’17
Source: Smith + Crown, CoinDesk, Outlier Ventures, Julius Baer; data as at
the close of 6 April 2017; The DAO=The Decentralised Autonomous Or-
ganisation (retired), a former on-chain, decentralised venture capital fund-
like structure
18.81(68%)
4,10(15%)
1.26(5%) 0.55
(2%)0.50(2%)
0.27(1%)
0%
10%
20%
30%
40%
50%
60%
70%
0
5
10
15
20
Bitcoins(Bitcoin)
Ethers(Ethereum)
Ripples(Ripple)
Litecoins(Litecoin)
Dash(Dash)
Moneroj(Monero)
Market capitalisation (lhs)
Share of overall cryptocurrency market (rhs)
Market cap. (USD bn) Share of overall market (%)
13
150
0.626
7
103
40
0
50
100
150
200
250
300
2013 2014 2015 2016 YTD 2017
Funds raised inICOs andsimilar tokenofferings
The DAO(outlier tokenoffering in2016)
Non-finalisedICOs andsimilar tokenofferings
USD mn
253
53
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All depends on implementation. Some blockchain
protocols are coded as to allow for dynamic cryp-
tocurrency supply and issuance management,
while others rely on hard-coded supply manage-
ment rules, or depend on mining activity rates.
Importantly, most blockchains being considered
for ‘industrial’ use do not typically involve crypto-
currencies, or involve them only because they ful-
fill a marginal technical function (e.g. ‘anti-spam’
features, as is the case for the Ripple blockchain).
Chart 3: ‘Blockchain’ slowly replacing ‘bitcoin’ in public mind
Source: Google Trends, Bloomberg Finance L.P., Julius Baer; XBT=Bitcoin;
data as at close of 2 April 2017
Cryptocurrencies are probably the most well-
known aspects of blockchain technology among
the wider public, which leads to some confusion
between the most famous of the cryptocurrencies
(Bitcoin) and the underlying technology (block-
chain). The Bitcoin blockchain, however, is but
one of hundreds of blockchain protocols already
developed. We will deal with the potential use
cases for Bitcoin and other cryptocurrencies fur-
ther below, in our use case discussion.
(2) Control
‘Control’ is a dimension which has been dutifully
explored by blockchain developers and prospec-
tive adopters. The fundamental idea is to diminish
blockchain’s decentralisation, transparency and
immutability properties in favour of privacy, secu-
rity and efficiency. The trade-off is clear: if some
degree of centralised control is reintroduced, a
number of optimising ‘tweaks’ become possible.
‘Permissioning’, which restricts participation in
the consensus mechanism only to a few vetted
and trusted participants, can lead to more cost-
and resource-efficient blockchains, as ‘permis-
sionless’ protocols (such as Bitcoin) generally re-
quire higher amounts of on-network energy ex-
penditure and computing power. When combined
with less resource-intensive and faster consensus
mechanisms (see ‘Consensus’ below), permis-
sioned blockchains thus have the potential to be
substantially more resource-efficient, private and
secure, over permissionless ones. In Table 2 be-
low, these trade-offs are briefly summarised.
Table 2: Permissioned and permissionless blockchain protocols compared, alongside traditional ledgers
Source: Paul Baran’s On Distributed Communications (1964), Credit Suisse, Julius Baer; *R3 CEV’s Corda is a distributed ledger solution inspired by block-
chain technology, but is not strictly a blockchain protocol — it is close enough to a permissioned blockchain, however, hence our categorisation above
0
200
400
600
800
1,000
1,200
0
20
40
60
80
100
2013 2014 2015 2016 2017
Google searches for ‘blockchain’ (lhs)
Google searches for ‘bitcoin’ (lhs)
XBT/USD exchange rate (rhs)
Index (adjusted) XBT/USD
NEXT GENERATION | BLOCKCHAIN: THE MISSING PIECE OF THE INTERNET | FRIDAY, 7 APRIL 2017, 10:26 CET 8/25
Likewise, if the possibility to read and initiate on-chain operations (modifications and transactions) is restricted
only to a few vetted and trusted participants, the blockchain is made ‘private’. This reduces the ‘hackable sur-
face’ of the blockchain, and relies on the off-chain integrity of participants to ensure that only relevant opera-
tions are conducted. Again, choosing private over public ‘read/write’ access renders the protocol more effi-
cient, private and secure. Table 3 below provides a matrix summary of the major examples of permis-
sioned/permissionless and private/public blockchain protocols.
Table 3: Permissioned/permissionless & private/public matrix summary of the major blockchain protocols
Source: BitFury USA Inc., Julius Baer
It should be noted that adding substantial
amounts of centralised control back into block-
chain protocols somewhat denatures them. In
fact, some DLT solutions developers, who work on
permissioned, highly-visibility access-segregated
and private ledgers for industrial use cases, do in-
dicate that their ‘recentralised’ and segregated
solutions are more accurately described as in-
spired by blockchain protocols, rather than block-
chain protocols per se.
Nonetheless, private and permissioned blockchain
protocols are currently the best candidates for in-
dustrial use, as they allow better compliance with
regulatory and commercial standards, in terms of
privacy, identification and legal ownership re-
sponsibilities, than their permissionless counter-
parts with decentralised governance.
It should be noted, however, that more recent
permissionless blockchain protocols, and their as-
sociated cryptocurrencies, have used advanced
cryptographic methods (such as ‘zero-knowledge
proofs’, or ‘ZKPs’) to ensure greater privacy of on-
chain identities and operations without compro-
mising the decentralised nature of their permis-
sionless protocols. Such blockchains and associ-
ated cryptocurrencies include Zcash, Dash and
Monero. These alternatives to Bitcoin have also
attempted to promote greater resource-efficiency
than most other permissionless protocols through
their choice of consensus mechanism, thus add-
ing to their efficiency.
(3) Consensus
As we have alluded to above, the choice of con-
sensus mechanism for a blockchain protocol af-
fects several of its properties and dimensions: its
degree of efficiency, whether or not a protocol re-
quires a cryptocurrency to function and the de-
gree of permissioning and privacy (of visibility,
identity and operation) assumed on-chain.
While proof-of-work (PoW), discussed above in
the context of cryptocurrency ‘mining’, has been a
very popular choice for permissionless block-
chains, an alternative known as proof-of-stake
(PoS) has been gaining ground.
Most famously, the permissionless Bitcoin com-
petitor known as Ethereum is transitioning to
such a PoS algorithm, in which participants ‘bet’ a
certain amount of cryptocurrency that consensus
can be reached and block creation can occur. This
orients the incentives of the participants in mak-
ing sure that consensus can be reached, but with
the threat of a ‘malus’ in case of failure rather
than the prospect of a reward in case of success.
Many other consensus algorithms have been de-
veloped for permissioned blockchains, and they
generally rely on a greater degree of implied, off-
NEXT GENERATION | BLOCKCHAIN: THE MISSING PIECE OF THE INTERNET | FRIDAY, 7 APRIL 2017, 10:26 CET 9/25
chain trust between participants, reflecting these
protocols’ more centralised design. Importantly,
both PoW and PoS can be more resource-hungry,
making them unattractive for industrial use cases.
(4) Contract
One of the most exciting emerging features of
blockchain protocols is the capacity to write code
and scripts onto the chain itself, enabling partici-
pants in the consensus mechanism to also run a
‘virtual machine’ and its decentralised applica-
tions as they maintain and update the blockchain.
The pioneer of this additional dimension — which
is often referred to as ‘smart contracts’, for rea-
sons which will be clarified below — was Ethere-
um, a blockchain protocol launched in 2015.
Ethereum includes a ‘virtual machine’ capability in
its code, allowing its network participants to write
and execute scripts on-chain that run infinitely
different decentralised applications (or ‘Dapps’)
on an automated basis.
This has often been touted as ‘smart contracts’,
given that this capability allows a blockchain pro-
tocol to become a trusted, automatic and decen-
tralised executor of contractual obligations be-
tween network participants. For instance, what we
now know as an off-chain corporate bond could
be simply transcribed on-chain as a piece of code,
delivering cryptocurrency or token payments at
given intervals to security-holders — much as a
real-world fixed income instrument would distrib-
ute coupons to bond-holders at fixed intervals in
time.
This additional dimension is full of promises, ena-
bling countless processes currently conducted in
the real world (with expensive notarisation and
verification procedures) to be moved on-chain.
(5) Tokenisation
The final additional dimension enabled by block-
chain protocols is the capacity to ‘tokenise’ real-
world, off-chain value (such as wealth, identities
or assets). We have spoken at length of crypto-
currencies, which are native, on-chain tokens or
assets created by certain blockchain configura-
tions. Tokenisation is altogether more revolution-
ary, allowing the digitalisation of real-world value
into seamlessly-exchangeable digital value.
Because of the likely sensitivity of digital asset
creation, it is unlikely that existing regulators will
allow mass tokenisation of off-chain value to be
conducted on permissionless protocols. This
means that permissioned protocols, which retain
some degree of centralised control, will be best-
positioned to capture the full potential of tokeni-
sation, with any type of security (shares, bonds,
derivatives, etc.) and ownership title (for real es-
tate, merchandise, etc.) holding the potential for
digitalisation and tokenisation.
Nonetheless, it is worth noting that some proto-
cols, such as the ‘coloured coin’ protocol devel-
oped to be overlaid on the Bitcoin blockchain,
seek to advance tokenisation on permissionless
protocols, with some very modest degree of suc-
cess.
Figure 5: A summary of the ‘value’ concept in the context of blockchain technology
Source: Julius Baer
NEXT GENERATION | BLOCKCHAIN: THE MISSING PIECE OF THE INTERNET | FRIDAY, 7 APRIL 2017, 10:26 CET 10/25
THE RANGE OF USE CASES FOR BLOCKCHAINS
Figure 6: Potential fields of application (use cases) for blockchain technology
Source: Julius Baer; P2P=peer-to-peer, C2C=consumer-to-consumer, B2C=business-to-consumer, KYC=know-your-client, AML=anti-money laundering,
B2B=business-to-business
ddd
SECTION INSIGHTS
Industrial-use blockchain protocols require some specific
properties in order to be implemented on a mass scale:
privacy, scalability and interoperability, to name a few.
This is mainly because blockchain operators and develop-
ers need to respond to commercial and regulatory re-
quirements.
While the technology itself has many merits for industrial
use, and holds an inherently strong disruptive potential, it
is highly likely that regulatory and competitive constraints
in a number of use cases will mitigate its short- to medi-
um-term disruptive potential. Therefore, adoption and co-
option of the technology by incumbents is highly likely.
We think cross-border payments and correspondent bank-
ing, as well as business-to-business (B2B) supply chain
and trade finance, present the strongest fields for radical
disruption. By contrast, adoptive dynamics are more likely
in capital markets’ post-trade infrastructure and in inter-
bank (non-cross-border) payments settlement. Further-
more, we do not see card and merchant payments net-
works as facing disruption. fff
ddd
An overview of potential use cases, needs, challenges
Given our current understanding of the capabilities and
potential of the technology, we recognise four broad fields
of potential applications for blockchain solutions going
forward, as summarised in Figure 6 above. We will focus
here on the two major fields, finance and trade, and how
these might be disrupted, or incrementally altered, by the
adoption of blockchain technology.
The running thread through each broad field, however, is
deeply shared: industrial blockchain solutions will need to
provide improvements over classical ledgers in order to
thrive. This means delivering on desirable properties, such
as control, security, privacy and efficiency. Visibility on,
and vetting of, on-chain identities will be especially im-
portant for industrial blockchain operators going forward,
both for commercial and regulatory reasons.
Moreover, additional criteria such as scalability (for high-
volume networks), resilience and sustainability (for
high-speed and long-duration networks) and interopera-
bility (to facilitate communication between existing infra-
structures and future and current blockchain protocols)
will be in great demand. Finally, blockchain solutions also
need to be used in areas where their properties are rele-
vant: that is, networks in which trust between participants
is relatively low, and in which the capabilities of the tech-
nology can be made to shine in terms of efficiency.
All of these desired properties place permissioned proto-
cols, developed for specific industrial cases and with in-
teroperability in mind, in a better position than permis-
sionless protocols for eventual adoption. While we do not
discount some disruption at the margins from cryptocur-
rency-enabled permissionless protocols (such as Bitcoin),
we are less convinced by their long-term capacity to con-
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IMPORTANT LEGAL INFORMATION
This publication has been produced by Bank Julius Baer & Co. Ltd., Zurich, which is authorised and regulated by the Swiss Financial Market
Supervisory Authority (FINMA). This publication series is issued regularly. Information on financial instruments and issuers is updated irregu-
larly or in response to important events.
IMPRINT
Authors Alberto Perucchini, Next Generation Thematic Research, [email protected] 1)
1) This analyst is employed by Bank Julius Baer & Co. Ltd., Zurich, which is authorised and regulated by the Swiss Financial Market Supervisory Authority
(FINMA).
APPENDIX
Analyst certification The analysts hereby certify that views about the companies discussed in this report accurately reflect their personal view about the companies and securi-
ties. They further certify that no part of their compensation was, is, or will be directly or indirectly linked to the specific recommendations or views in this
report.
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Structure
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Disclosure No specific disclosures.
Equity research
Frequently used abbreviations
CAGR Compound annual growth
rate
EPS Earnings per share P/B Price-to-book value
DCF Discounted cash flow EV Enterprise value P/E Price-to-earnings ratio
EBIT Earnings before interest and
taxes
FCF Free cash flow PEG P/E divided by year-on-year EPS
growth
EBITDA Earnings before interest, taxes,
depreciation and amortisation
MV Market value ROE Return on equity
Consensus
rating
Consensus rating indicates the
analysts' opinions on the security.
It shows the number of analysts
covering the security and the
breakdown between Buy, Hold
and Sell ratings.
Consensus
target
The consensus target is the
average price to which analysts
expect the security to rise.
FY Fiscal year
Equity rating allocation as of 12/04/2017
Buy 31.4% Hold 65.8% Reduce 2.8%
Julius Baer does not provide investment banking services to the companies covered by Research.
Equity rating history as of 12/04/2017
Company Rating History
Bank of New York Mellon Hold (Initiation of coverage) Since 02/06/2016
International Business Machines Hold Since 19/07/2007
Mastercard Buy (Initiation of coverage) Since 04/05/2011
NASDAQ OMX Group Buy (Initiation of coverage) Since 03/06/2015
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UBS Group Buy Since 05/02/2013
Visa Buy (Initiation of coverage) Since 02/12/2014
Rating system for global equity research (stock rating)
Buy Expected to outperform the regional industry group by at least 5% in the coming 9-12 months, unless otherwise stated.
Hold Expected to perform in line (±5%) with the regional industry group in the coming 9-12 months, unless otherwise stated.
Reduce Expected to underperform the regional industry group by at least 5% in the coming 9-12 months, unless otherwise
stated.
Frequency of equity rating updates An update on Buy-rated equities will be provided on a quarterly basis. An update for Hold and Reduce-rated equities will be provided semi-annually or on
an ad-hoc basis.
Risk rating systerm for global equity research (stock rating) The risk rating (High/Medium/Low) is a measure of a stock’s expected volatility and risk of losses in case of negative news flow. This non-quantitative
rating is based on criteria such as historical volatility, industry, earnings risk, valuation and balance sheet strength.
Thematic research / Next Generation
Theme exposure rating (“NG Rating”) for Next Generation research Companies are rated according to exposure towards a given theme or topic. Any theme exposure rating (“Next Generation Rating” or “NG Rating”) must
be understood in connection with a corresponding theme or topic. Companies’ exposure is rated as outlined in the table below.
High Company which business model is defined by its role in providing critical services/products consistent with the investment theme or
topic, and showing a high sales share in the context of the theme or topic.
Medium Company which business model is defined by its role in providing services/products consistent with the investment theme or topic, but
showing a moderate sales share in the context of the theme or topic.
Low Company which business model is not defined by its role in providing services/products consistent with the investment theme or topic,
but showing limited or projected sales exposure in the context of the theme or topic.
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