Blockchain technology. Future for supply chains?

1. Abstract

The first section covers a description of the blockchain technology addressing readers not deeply familiar with the necessary blockchain terminology and details for understanding the potential impact on business applications and Logistics / Supply Chains. In the recent past first blockchain applications concentrated on the financial sector, resulting in disruptive business models <FinTechs> challenging primarily banks and other legacy systems depending on trusted intermediaries like insurances or notaries. The spectrum of blockchain attributes enables this technology being applied in other business sectors, like Healthcare, Energy, Telco, Real Estate and Retail. – Now the logistics / supply chain area enjoys rather high attention. The report summarizes actual initiatives and pilot applications. -Finally the report proposes an innovative supply chain structure based on blockchain technology – for discussion.

2. Introduction

In public-/, business-/ and private life many processes are complicated and time consuming because simple transactions cannot be executed on a peer-to-peer basis because of lacking trust between the peers. Banks are needed for transferring money between business- or private partners. Notaries and banks are needed for the procedure of buying a house (real estate). Even for simple purchasing processes banks are needed – as a trust ensuring organization. – If you buy something via Internet your solvency is checked along formal criteria. But you do not know what the criteria are and who will have access to this information. On the other hand online shops use the service of third party organizations for presenting certificates which are to prove the trustworthiness of the shop. Examples are EMOTA (European Trustmark) or the BEVH/EHI Certificate – just to give 2 examples. – These examples show how deeply trust is affecting daily business life.

Trust providing institutions represent " central points of failure" likely becoming the target of hacking attempts. The same holds for cloud providing services. Ongoing digitization puts security of data into the focus – also for audit trails. In addition transparency of data in real time across companies is regarded as key for improving/automating business processes – especially in logistics / supply chains. From Just-in-Time Deliveries we now move to "Just-in-Time Transparency".

3. Blockchain Technology

An easy explanation of blockchain technology to IT-laymen is difficult. There are highly professional textbooks dealing with blockchain technology and areas of application 01, 02, 03. But for people not familiar with computer logic and language it seems to be rather difficult catching the technical clues and understanding the impact in real (business) life. Countless blogs and videos for explaining blockchain technology are offered in the Internet. But unfortunately they often use the same 'IT-expert's language'.

Understanding Blockchain

One approach for understanding the development of the modern, IT-driven world is looking at computer paradigms from the past. Five paradigms in line can be identified. The first two are about Mainframe and PC (Personal Computer). The Internet (paradigm three) revolutionized rather everything by connecting people and businesses. Based on the Internet platform the social and mobile networking represents the most recent paradigm. As a result new internet-based business models arose and customer behaviour changed significantly. The current emerging paradigm might be called "connected world of computing" relying on blockchain cryptography 01.

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Exhibit 1 Five computing paradigms Source: modified from 01

In this connected world blockchain technology can be seen as the economic overlay to the variety of multi-device computing – including IoT (Internet of Things) sensors, smartphones, tablets, laptops, smart home, smart car and smart city. The past has shown that the Internet Technology enabled tremendously improved and cheaper connectivity. Now the block­chain technology and its disruptive potentials knock at the door of traditional structures and procedures of transactions. In his famous paper "The Nature of the Firm" (1937) the Nobelist (1991) Ronald Caose specified 4 kinds of transactional costs in companies: Search, Coordination, Contracting and Trust 04. Blockchain is offering disruptive solutions for all of them in different fields. The most obvious effect is potentially replacing trust providing intermediaries like banks, notaries, lawyers, etc. The big question is – by when in time?

"The Truth about Blockchain", a paper recently published in Havard Business Review by Marco Iansiti and Karim R. Lakhani 05 describes the path blockchain is likely to follow based on the experience of the adoption of the Internet Technology (TCP/IP). They conclude that for blockchain it also will take years because the economic, legal and political systems and their bureaucracies – protecting assets, setting organizational boundaries, verifying identities, governing interactions among nations, organizations, communities and individuals – have not kept up with the economy's digital transformation. Now blockchain technology beyond crypto-currencies is in the early phase of first business use-cases and tests.

What is a Blockchain?

Definition 1 : Blockchains are a way of ordering and verifying transactions in a distributed ledger, where a network of computers maintains and validates a record of consensus of those transactions with a cryptographic audit trail. <KPMG 06>

Definition 2: Blockchain is a platform managing value of any kind, for enabling customers, companies and authorities to interact safely under permanently growing application scena­rios. <Deloitte 07>

Definition 3:

- Technically: The Blockchain represents an open decentralized database keeping a visible public ledger.
- Economically: The Blockchain represents a network for exchanging goods and services without including intermediaries.
- Legally: The Blockchain validates transactions excluding trusted institutions like no­­- taries or other middle-men. <Datarella 08>

The original Blockchain Technology

The innovative idea behind blockchain is an open, distributed and encrypted Database ("Ledger") maintained and updated in parallel by numerous registered users – spread all over the Internet – the so called "miners" (also called "nodes") of the Bitcoin network. The architecture of the ledger is a chain of time-stamped interlinked data blocks. Each block contains a header including a "Nonce", transaction data and the related "Hash". The feasibility of the transaction is checked for verification by the miners ("Proof of Work"). After verification by the majority of miners a block is linked to the chain based on Hash-technology. Miners are competitively "digging" (try and error) for identifying the "Hash" of the previous block. Given the computational power of all miners the process takes 10 minutes at the actual difficulty level of creating hashes with '0000' in the beginning. The winner is rewarded by a specified number of Bitcoins. Once being linked to the chain the current block (and of course all previous blocks) cannot be changed forever. Modifications, amendments and even hacking the blocks practically is impossible, because any blockchain exists manyfold in parallel on many associated computers in the Internet.

Glossary / Terminology

Ledger – an open database storing all verified transactions of the blockchain; Tokens – represent values handled in blockchains; Intrinsic (Native or "Built-in") Tokens represent incentives for miners Asset-backed Tokens represent values for transactions Miner / Node – a registered user providing computer capacity for storing all blockchains; checking / verifying the feasibility of transactions and competing with other users / miners for solving the Hash-Problem. Nonce – Integer number for systematically modifying the data to be hashed; In case of Bitcoin the header of the block and the transaction data are hashed representing the data set for hashing. Hash – a 32 bits random string representing any set of data – independent of data volume – comparable to a fingerprint of the data set; Proof-of-Work – finding the solution of the mining process; i.e. finding the hash of the previous block – in Bitcoin starting with '0000'.

The architecture of the blockchain enables transferring money (Bitcoins) without any bank acting as the trust providing intermediate institution. Double spending of the same Bitcoins is impossible. So the process is safe, not too slow (by now taking about 10 minutes for con­sensus) for sending money around the world (Peer-to-Peer). The economic advantage – much lower fees than in traditional banking – represents a significant challenge for the financial business environment. This is why blockchain might be called the "Trust-Machine". Another summary of blockchain is given by Florian Glatz (Blockchain Lawyer) "Blockchains convert Data into Facts!" 09

More advanced / specialized Blockchains

Smart Contracts

The principle of blockchain technology offers by far more potential applications beyond transferring digital money. One idea of extending the scope is replacing Bitcoin (money) by "assets" of any kind (e.g. houses, paintings, music, licences, …) and extending specified transaction data to program codes applying <If This than That>. This idea enables "smart contracts" [Exhibit 2] to be executed automatically and exactly as agreed along the block­chain network. The blockchain of Ethereum provides this option [Exhibit 3].

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Exhibit 2 Source: [ 10] Exhibit 3 Source: Modified from [ 11]

Modifications of elements of the basic Bitcoin Blockchain process lead to creating different digital currencies and thus modified blockchain procedures. At the moment there are more than 800 digital currencies on the market.

The modifications of blockchain procedures follow business requirements. Open public blockchains are not suitable for all types of smart business contracts. Confidentiality between business partners has to be guaranteed – e.g. for individual rebate schemes. Therefore private block­chains can be set up for communities – even Peer-to-Peer. The rules (rights) for validating blocks (the job of the miners in Bitcoin Blockchain) and the permission of access can be agreed by the community.

Clearmatics (UK), a "smart contract" provider <see Exhibit 3>, advertises their blockchain services on their homepage: "Building on the promise of distributed ledger technology, Clearmatics' "Distributed Virtual Machine" (DVM) combines logic with ledger to achieve true distributed automation of business processes. By leveraging the power of the DVM, leaders and entrepreneurs in finance, internet of things, manufacturing, and other industries will be able to create new business models and redesign processes to drive innovation."

Smart Contracts represent the core of potential business applications of blockchains. Therefore the flexibility of smart contract design becomes relevant. There are offers available with two levels of complexity:

(1) Template-based contract logic
(2) Unlimited use of computer codes (called: "Turing Complete" contracts)

Exhibit 4 gives some examples.

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Exhibit 4 Smart Contracts and Blockchains Source 10

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Token

In the environment of blockchain there are 2 kinds of tokens;

(1) Intrinsic tokens (also known as ‘native or ‘built-in’ tokens)

Some of the better known examples of intrinsic tokens are:

- BTC on the Bitcoin blockchain
- XRP on the Ripple network
- NXT on the NXT platform
- ETH on Ethereum

These tokens can be interpreted as the grease of the blockchain. They represent some value supporting the motivation of miners in the consensus (block making) process and/or avoiding spam.

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Exhibit 5 Role of Intrinsic Tokens Source: 12

"These ‘coins’ or ‘tokens’ really are part of the core of the blockchains and the blockchains would not run without them. They are usually part of an incentive scheme to encourage people to help validating transactions and create blocks (block-maker), or in Ripple’s case, they are there to create a small cost per transaction which helps prevent transaction spam." 12. In Bitcoin the BTC are mined and assigned to the block-makers. - In Ripple the pre-mined XRP are shared among the key users. Each transaction has a fee costing a small amount of XRP. These XRPs are destroyed over time, and not re-assigned to the transaction validators. The total number of XRPs in circulation goes down with time. – In Ethereum, ETH (‘Ether’) are pre-mined. Transactions and smart contracts need ETH to get created and run, and they go back to the block-maker as a reward.

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