Blockchain for Organisations.
Prediction: almost all organisations will incorporate blockchain in the future.
Part 1 looks at how an organisation’s functions can be decentralised and paid for with a token, thus eliminating expenses.
Part 2 looks at how an organisation can use blockchain internally for better auditing, thus reducing the risk of fraud.
Part 3 looks at how cryptocurrencies can replace the traditional stock instruments and the benefits of doing so.
Part 1: Tokens & Functions.
Organisations are formed to carry out functions. A subset of these functions are done internally. Another subset of these functions are outsourced. Functions can be outsourced to other organisations or to the community. When a function has been outsourced to the community, it can be considered as decentralised. For example, Bitcoin outsourced transaction validation to the community.
Organisations are formed to carry out functions. A subset of these functions generate revenue. Another subset of these functions incur an expense. Expense incurring functions are needed so that the revenue generating functions can be carried out, if not then the expense incurring function will be dropped by a profit seeking organisation.
Expense incurring functions that are carried out internally are paid for indirectly by the organisation because the organisation will spend money on employees, resources and equipment to carry out the function on its behalf. Expense incurring functions that are outsourced to another organisation are paid for directly by the organisation because the organisation will pay money to the other organisation. Expense incurring functions that are outsourced to the community don’t have to be paid for with cash, instead a token can be used to pay. The token payment isn’t an expense to the organisation as no money is spent.
A profit focused organisation will seek to maximise revenue and minimise expense. Rewarding community participation in carrying out a function with a token will reduce the total expenses of the organisation. However there will be an expectation from the community that the token can be redeemed for perks. Some of these perks might be enjoying the benefits of revenue generating functions that an organisation provides, this means the future revenue of the organisation might decrease. If expenses are expected to reduce by more than revenue reduction, then the integration of a token will have a positive impact on profit.
Let us consider the Bitcoin use case. Bitcoin can be thought of as an organisation that carries out two main functions: allowing transactions on its network and validating those transactions. Bitcoin outsources the transaction validation function to the community and rewards those who participate with tokens. The community can redeem the tokens for the perk of being able to transact on the network. Bitcoin has no cash expenses as its expense incurring function is outsourced and paid for with a token it created. Bitcoin has no cash revenue as its revenue generating function can be paid for with the token it created. Bitcoin itself has zero cashflows but has created a new asset in the form of the tokens. As of 1 June 2022, the market cap of the tokens in circulation is over $600 billion, and about 10% of the total token supply still needs to be created. New blockchains like Ethereum allow any organisation to create its own token and scaling solutions like Polygon make it affordable.
Blockchains provide the infrastructure and security for various token functions. Tokens can be minted only according to a predetermined set of rules. Tokens can be safely transferred, either peer to peer or via an exchanges. Tokens can be redeemed for perks such as transacting on a network, voting in governance protocols, utilising a service, exchanging for a product, etc. Tokens can be created without blockchain but then security, transparency and immutability are compromised. It is therefore recommended that organisations issue their tokens on a blockchain.
An organisation needs to decide which expense incurring functions can be decentralised and which functions can be redeemed as perks. All high expense incurring functions should be considered for decentralisation, can the organisation reward the community with tokens to carry them out on its behalf? For example, some of the community members could submit designs for the organisation’s logo and the rest of the community vote on which one should be chosen? Pepsi paid The Arnell Group $1 million to update their current logo and some experts believe that a logo should be updated every five years. If an organisation had a circulating token they could set up a contest for their community members to submit updated logo designs where the rest of the community spends their tokens to vote for their favourite design. The tokens transfer from the voters to the designers and the design with the most votes becomes the new logo of the organisation. The voters lose their tokens but gain the perk of having their say in the new logo of the organisation. All the designers receive tokens from voters but only the one with the most votes will see their design as the new logo of the organisation. The organisation facilitates community engagement and receives an updated logo that their community approves of without incurring a cash expense.
Logo design is a generic function for organisations but more specific functions can also be decentralised. For example: Funeral Insurance in South Africa. It is a product that is in high demand but riddled with fraud. Funeral Insurance in South Africa is a form of micro-insurance where the payouts are so small that they don’t justify a comprehensive claim process and are so vulnerable to false claims. At the moment many insurers simply price the fraud into the product and thus carry this cost onto the consumer making Funeral Insurance incredibly expensive from an actuarial point of view. An insurer could decentralise the claim validation process by getting the local communities to collectively root out fraud. Instead of submitting your claim to the insurer, you submit your claim to the community. The community then votes whether or not the person in question actually died. If a member’s vote is in consensus with the rest of the community, their token balance increases by a small amount. Each community can have its own token linked to a reserve pool facilitated by the insurer. If the community tries to collectively game the system by saying yes to every claim, then the token they receive as a benefit will be hit with inflation. It would require significant education and administration to decentralise the claim process but if the total cost of doing so is less than the additional revenue that will come from a more affordable premium, then insurers will be wise to consider it.
Part 2: Blockchain & Fraud.
All organisations are exposed to the risk of fraud. Fraud occurs when a bad actor uses deception for personal gain at the organisation’s expense. Bad actors can be at any level of an organisations hierarchy, from low level employees creating false invoices to high level management misappropriating assets and covering it up in the financial statements. Fraud is possible when bad actors have the opportunity to manipulate information.
To combat fraud at the low level internal policies and processes are put in place to control information. To combat fraud at the high level independent accounting firms are called in to audit and sign off on the information presented in the financial statement. The top four accounting firms each have an annual revenue of around $40 billion. Yet the infamous Enron scandal showed that the accounting firms can be part of the fraud and so they are not a perfect solution.
The main function of an auditor is to validate the information presented in the financial statement. This is needed because information can be manipulated in existing centralised systems. The success of Bitcoin is partially due to the fact that the information of its transactions cannot be manipulated because of the way the blockchain works. Information on the blockchain is immutable, this means it cannot be changed. Blockchain won’t replace auditors but it will drastically reduce the amount of time they need to validate information and so their fees will come down considerably. Small organisations pay a higher percentage of their revenue to auditors than larger organisations and so a blockchain solution isn’t reserved for just the biggest enterprises.
Incorporating blockchain into an organisation’s information systems won’t just reduce the auditors fees but will also provide the following benefits: One, internal fraud will be reduced as bad actors won’t have the opportunity to manipulate information for their personal gains. Two, having all the organisations information on the blockchain will give management better access to it, providing them with the insights needed to make more efficient decisions.
For example an insurance company is vulnerable to a fraudulent attack during the claim payment process. When a policyholder makes a claim that is 50% below their threshold, the bad acting employee could intentionally pay double. The bad acting employee then contacts the policyholder and deceives them into believing that they had made a mistake and asks them to return half of the payment. The bad acting employee provides the policyholder with their own personal banking details. The policyholder then sends half of the amount to the bad acting employee. The bad acting employee can get away with their crime by doubling the claim amount on the system. If an insurer had a blockchain in place, it would be impossible for the bad acting employee to change the claim amount. Thus an auditor would quickly pick up that the amount paid didn’t match the claim amount and an investigation can be launched to understand what happened.
Accounting firm EY and Polygon have created Nightfall, a blockchain solution that reduces transaction fees and introduces privacy. Before enterprises had two options, either create their own private blockchain or use a public blockchain. A private blockchain gives them privacy, low transaction fees but little security. A public blockchain, like Ethereum, gives them security but no privacy and transaction fees are high. Using Polygon, a scaling solution for Ethereum, directly would give them security and low transaction fees but not privacy. Nightfall gives security, low transaction fees and privacy. Nightfall’s beta was released in May 2022.
So far we have been discussing information within an organisation but information is also shared across organisations. This information isn’t currently immutable and so the opportunity for fraud is present. Consider the honey industry where honest beekeepers are having to compete with an artificial blend of corn and rice sweeteners that pretends to be authentic honey. Both consumer and retailer would benefit from the knowledge of the supply chain of the product they are buying and selling.
In our global economy organisations are interacting with each other across borders and have to deal with language and cultural barriers. Using a blockchain with immutable information will help organisations on both sides of the deal to better trust each other. More trust will result in more deals and wide adoption of blockchain is likely to cause an increase in the world’s economic activity.
Bitcoin’s impressive market cap has shown that there is demand for even simple immutable information. Ethereum allows for more complex information to be immutable and scaling solutions like Polygon are making this accessible to organisations. Immutability reduces the risk of fraud and whenever a business risk is reduced, economic activity tends to increase.
Part 3: CryptoStocks, the future of shares.
The value of the global equity market is around $117 trillion. Listed shares are tradable instruments that represent ownership in an organisation. Shares normally give holders voting rights and some might pay out a dividend. Shares are also collateralised but if an organisation fails, debt holders and other stakeholders are paid out before the shareholders. Shares are usually traded on an exchange and are subject to a variety of fees. Shares are also heavily regulated and an organisation needs to meet many requirements before they can list on an exchange. Exchanges are fragmented and each country will have its own set of rules. It is getting easier but still it can be a challenge for a person in one country to purchase shares in an organisation that is listed on an exchange in another country. The listing expense and the minimum market cap requirement prevents the majority of organisations from enjoying the benefits of having tradable shares.
A DEX is a decentralised crypto exchange and many of them have no listing requirements. Organisations can create tokens that represent ownership and list them on a DEX.
This article is still being written. Check for updates.
