The World Trade Organisation is pragmatically bullish on blockchain
All pragmatic, level-headed and well-informed roads lead to distributed ledger technology.
Money makes the world go around, and trust makes money go around. In that context, it's easy to see why the World Trade Organisation (WTO) was eager to examine how blockchain technology, as a "trust machine," can bring further revolutions.
The WTO World Trade Report 2018 (PDF) took a deep dive into blockchain among other emerging technologies, and in its findings struck a pragmatically optimistic tone.
"These technologies have the potential to reduce trade costs further and to transform international trade profoundly in the years to come," the WTO says.
The findings in brief
The WTO's findings might be distilled as follows:
- On paper, distributed ledger technology, broadly referred to as "blockchain," is undeniably the bee's knees and worth the hype.
- The three main limitations are scalability, the digital island problem and a lack of legal recognition.
- Scalability and the digital island problem will be solved with time, like it or not, but fixing the lack of legal recognition will require a conscious and cooperative multinational effort.
The trust machine
The WTO report framed distributed ledger technology as a "trust machine," and approached it as such throughout its report. Essentially, this refers to how it can use immutability and decentralisation to manufacture trust and deploy it as needed.
The concept is often referred to as "trustlessness" in that blockchain technology can replace the need for trust with something better. The idea is that you don't have to do anything as primitive as actually trust someone, which by definition requires a certain element of faith and a chance that your trust might be misplaced. Instead, you can lean on transparent and immutable automation.
- When you're in a trusted relationship, you're hoping the other party acts appropriately. You trust them because on the balance of probability, you think they have an acceptable chance of acting appropriately, and you know there are remedies if they don't. These relationships are extremely inefficient. They take a long time to build, present limited options, are often unreliable and will periodically require the use of expensive remedies.
- When you're in a trustless blockchain relationship, you know the other party will act appropriately. You don't have to trust them because you know there's theoretically a 100% chance of the other party acting appropriately and still know that there are remedies if they don't. These relationships are highly efficient. They can be built instantly and anywhere as needed, bringing together two parties of almost any kind, and theoretically never have to involve the use of expensive remedies.
Whether someone refers to blockchain as a trust machine or a trustlessness machine might purely be semantic, but in both cases, the idea is that blockchain can digitise trust, which can be deployed wherever it's needed.
Trust is crucial in trade, as the WTO notes, because at the nitty gritty end of things, international trade can be described as a system where countless different parties are constantly forming and dissolving relationships with countless other parties.
Being able to apply trustlessness to the edges of these connections, like applying a drop of glue, can bring incredible efficiencies. And once the glue has dried, it's strong enough that you can reliably automate things that were once impossible.
Centralisation and scaling
The report identified a series of remaining obstacles for blockchain technology. And while the WTO wasn't too put out by existing technical limitations, it did acknowledge that there's still a lot of work to be done.
It also pointed out that proof-of-work blockchains, specifically bitcoin and Ethereum (in its PoW rather than PoS incarnation), might currently be moving in the wrong direction due to the inevitable centralisation that all proof-of-work networks will succumb to.
"Hacking a blockchain network is economically inefficient and extremely hard in practice, but a 51 percent attack – i.e. an attack by a group that controls more than 50 per cent of the network's computing power – is not impossible. In fact, the computing power capacity of the Bitcoin and Ethereum blockchains is increasingly aggregated. This potential vulnerability remains subject to debate in the information technology (IT) community," the report said.
It also gave a shout out to IOTA as an example of the next generation of DAG distributed ledgers in the context of the advances being made to help solve scaling problems.
The digital island problem
The second major obstacle the WTO identified was the "digital island" problem. This refers to the problem of having too many competing standards and not enough interoperability. It noted that this was more in the nature of a delay rather than an endemic problem though.
"Existing blockchain networks and platforms have their own technical specificities and do not "talk to each other". Organizations such as the International Organization for Standardization (ISO) and the International Chamber of Commerce (ICC) have started to look into issues of interoperability and standardization and various technical solutions are being developed by IT developers," it said. "However, solving the "digital island problem" is likely to take time."
"Finally, the use of blockchain technology raises a number of legal issues, ranging from the legal status of blockchain transactions (whether blockchain transactions are recognized legally) to applicable law (which law applies in the case of a blockchain spanning various jurisdictions), and liability issues (who has liability if something goes wrong and what resolution mechanism applies in case of conflict), not to mention possible compatibility issues with existing regulations," the WTO says.
It also suggests that this obstacle might need to be tackled with more deliberation than the others.
This is because existing international trade standards are well established, offer a reliable level of legal protection and are baked into the systems of most participants. But until blockchain systems can provide the same level of legal protection, it's unlikely to see significant uptake.
Scaling solutions and an answer to the digital island problem are already in motion, but more meaningful work is needed on uniform and effective global regulations for blockchain.
"Currently, compliance of documents with International Chamber of Commerce (ICC) rules – the ICC currently provides for the legal and professional rules standardising letters of credit and other trade finance instruments internationally – leads to automatic provision of a letter of credit with legal obligor status, with the Society for Worldwide Interbank Financial Telecommunication (SWIFT) providing the payment channel to do so," the WTO explains.
"By contrast, under blockchain transaction technology, there is still considerable uncertainty regarding the professional and legal standards applying to trade finance transactions, for example: who has liability at what point of the transfer of data and payment; when is obligor status confirmed; and who are the recourse authorities.
"Ultimately, whether blockchain will succeed in digitalizing trade finance will depend on whether current regulatory challenges are effectively tackled and whether the benefits associated with the use of the technology outweigh the costs of moving away from existing systems – which simply entail sending digital versions of documents. The current system may be costly, paper-intensive and burdensome... according to Maersk, documentation and bureaucracy can represent up to one-fifth of the total cost of moving a container.... but it is efficient in terms of legal protection. The jury is still out."
Digitisation leads to blockchain
The WTO also made note of how blockchain technology might influence specific areas. In particular, it noted how the increasing prevalence of digital goods in international trade could be well-supported by blockchain technology.
This shift to digitisation is already happening extremely fast. When was the last time you bought music, a book, a movie, a video game or similar in a physical form? How long will it be before you can no longer buy physical event tickets? And how long will it be before the shipping of physical goods starts being replaced by downloadable blueprints to run off a 3D printer?
The paper astutely notes that as digitisation changes the revenue breakdown for entire industries, the needs of that industry will change in response.
As one example, once an entire industry shifts to digitisation, the remaining physical aspects start representing an outsized cost, which suggests that people start looking for more ways to eliminate those and go 100% digital. This search will start driving more industries towards blockchain technology over time.
For another example, consider the WTO's chart below. It shows the breakdown of revenue sources for the US music industry from 2016 to 2017.
It's a staggering difference across just a single year. Note that from 2016 to 2017, total digital download revenues dropped sharply, even falling below the also-dropping total physical value. At the same time, streaming kept growing.
For the industry as a whole, their profit makeup is changing dramatically. Specifically, from digital download revenues to streaming. This brings new cost differences too, making it more important to deliver streaming cost-effectively.
So as the relatively straightforward physical and digital download system (choose your music and add it to your cart) gives way to more flexible streaming (switch your music on and off), elements like royalties start posing an outsized problem. Streaming doesn't let one just sell records and give each stakeholder a set percentage. Rather, it involves much more meticulous data tracking, pressures like the need for a streaming service to be profitable while still offering free music within a freemium business like Spotify uses and similar.
The result is that many streaming services are running at a loss even as artists also make a pittance. The problem might be seen as streaming services arriving with a very tempting product at a time when the industry infrastructure is still geared towards physical sales and downloads, occupied with an incredible slew of expensive middlemen and still unable to completely ignore the sizable download and physical market.
These growing problems have already sparked a race to find effective blockchain-based music royalties solutions in music and video games.
"New technologies may help to replace the complex and obscure royalty regimes by which the industry currently pays artists with simpler mechanisms that benefit both artists and consumers," the WTO notes.
The tip of the iceberg
The goods themselves aren't the only part of global trade which can stand to be digitised. The WTO acknowledges that blockchain solutions can touch on just about any element of the trade chain, including the following:
- Payments: "[Ripple] gives banks the ability to convert funds directly into different currencies in a matter of seconds and at little to no cost, without relying on correspondent banks."
- Trade finance: "Trade finance entails a credit or a guarantee operation, implying deferred payments. Experiments in this field aim to digitalize the movement of documents necessary for the credit and element of guarantees to proceed – and to link the financial intermediaries, the exporters and importers, and the merchandise (the collateral in many cases) together digitally."
- Supply chain finance: "The objective is to digitalize the cascade of payables and receivables between buyers and suppliers within existing supply chain relations. The use of the blockchain technology could enlarge the potential scope of supply chain finance by making it easier and less risky to process B2B payments between companies that do not have a pre-established relationship. Some start-ups already offer blockchain-based, real-time 24/7 B2B payment solutions that bypass letter-of-credit processes."
- Verification: "Blockchain technology has the potential to reduce verification costs greatly. This is likely to increase transparency and expand trade along value chains. Another potential impact of blockchain technology on value chains works through its effects on matching costs between upstream suppliers and downstream buyers. Such costs often arise due to a lack of trust, which is not an issue in blockchain-based transactions."
- Contract enforcement: "Technologies such as blockchain can circumvent intermediaries in trade and lower demand for contract enforcement institutions. There is also evidence that standardized information provided by digital technologies can reduce the importance of trust and reputation in online transactions (Agrawal et al., 2016). They find that this can in particular boost the exports of digitizable products from developing economies."
- Border procedures: "When trade becomes digitalized, underdeveloped infrastructure and ineffective border procedures might become less burdensome. Along the same lines, advances in technologies like blockchain can overcome weak contract enforcement abilities."
Disclosure: At the time of writing, the author holds ETH, IOTA, ICX, VET, XLM, BTC and ADA.