Fast, transparent and secure, they offer more efficient, lower cost and permanent ways to process, verify and store data. In many cases, DLTs can vastly improve existing processes both within, and between, organisations and individuals. They can also create new opportunities to innovate.
Investors wishing to participate in the adoption of DLTs can do so by investing in their native digital assets, which are needed to pay for usage. Given the short history of the industry, a diversified approach across several is preferred.
DLT and how it works
DLTs use cryptography to store data securely on digital ledgers. These ledgers are then distributed across networks of nodes (individuals or groups who operate the network), where the nodes validate updates of their respective ledgers through a consensus algorithm.
DLTs can vary in the way they reach consensus and have different characteristics in terms of speed, security, running costs, transparency and options for customisation.
Proof-of-work
The Bitcoin blockchain uses a proof-of-work (PoW) consensus algorithm which requires the operators (in this case, ‘miners’) to update the blockchain by solving a simple, but extremely large, mathematical puzzle.
Miners are rewarded for performing this service in the form of Bitcoin, the native token of the Bitcoin blockchain. As miners compete for rewards, the mathematical puzzle increases in size, requiring more energy to be expended to solve it.
PoW is very secure by design as ‘bad actors’ would be required to expend more energy (and thus more cost) to alter records on the blockchain. However, PoW is also slow to process updates and can be extremely energy intensive, resulting in high running costs and large carbon emissions.
Proof-of-stake
Proof-of-stake (PoS) is another consensus algorithm whereby, instead of solving a puzzle, nodes (called ‘validators’ in this case) check and come to a consensus on the updates to their respective ledgers.
Validators are rewarded in the native token for validating transactions on ledgers. To ensure that PoS is secure, nodes must own some of the native DLT token (hence the ‘stake’). This means a bad actor would need to acquire a large proportion of tokens to attack the DLT. PoS consensus DLTs vary in how they treat this token ownership and the rights it confers.
Importantly, PoS requires significantly less energy to validate transactions than PoW. For example, when Ethereum, the largest PoS consensus blockchain, moved from PoW to PoS last September, energy consumption for the network dropped by 99.95%. Some DLTs, such as Hedera Hashgraph, are able to reduce energy consumption for validation even further.
The power of DLT to improve…
DLTs process and store data quickly and securely, and are immutable, meaning they can’t be altered. As such, they have broad applications across most industries where data processing is required.
For example, in financial services, DLT can be used to streamline ‘know-your-client’ processes. Individuals and groups can have sensitive data verified seamlessly, without the need for openly presenting this data (and having information divulged unnecessarily).
In the manufacturing and consumer goods industries, supply chains can be monitored and analysed on a digital ledger. In a world where transparency of supply chains is becoming increasingly important, a public distributed ledger can provide the trust that consumers and intermediaries require.
The health industry is home to some of the most sensitive personal data, with public and private healthcare providers across the world suffering data breaches. DLT can provide a safe and secure solution to storing sensitive data while also making it usable only by authorised people, such as medical professionals. Additionally, interoperability between DLTs would allow for easy access and transfer of information for patients moving healthcare providers.
…and to create something new
In addition to making existing processes more efficient, DLT opens up the possibility for new forms of data management that would otherwise be impractical.
The technology can also be used to tackle piracy issues in music and entertainment by memorialising the unique data behind songs or films on a ledger, while artists can benefit from greater financial democratisation and autonomy through royalty distribution built into smart contracts.
In financial services, DLT offers powerful democratisation benefits through the tokenisation and fractionalisation of financial assets. Investment opportunities previously available to only the largest institutional investors (such as direct real estate, infrastructure and other alternative asset classes) can now be offered to individuals seeking greater control and diversification of their financial investments.
The investment case for digital assets
Validator ‘rewards’ in a PoS consensus DLT are provided by users of the technology. When a company uses the technology, they must purchase and ‘spend’ the native token for that DLT.
For example, in the case of Ethereum, validators are rewarded by users in ether (also known as ETH). Many DLTs have a controlled and, ultimately, finite issuance of tokens. Therefore, as adoption and use of public DLT increases, demand for digital assets will increase, leading to a rise in their value.
Currently, speculation clearly dominates these markets. However, this is a nascent technology and adoption is at an irreducible fraction of its ultimate potential.
In that sense, it is reasonable to expect that, in the future, a far greater proportion of the demand and activity in digital assets will come from the application of DLTs rather than from speculation.
Investing early
Given what we now know about the success of Excel, most people would jump at the chance to go back in time and invest in that technology (were it investible). However, we now have the benefit of hindsight, while in its infancy, Excel was competing with several other spreadsheet packages as well as resistance from users of ‘old’ tech.
The DLT industry is in a similar position now. We can see the momentum of adoption building but it’s still unclear which technologies will see the greatest adoption over time.
Investors can participate in, and profit from, the growth of individual DLTs by purchasing and holding the related digital assets. Over time, adoption metrics may provide an indicator for future price movements. However, it is still too early to make these predictions.
Therefore, the suitable approach for most investors is to allocate to a diversified basket of assets, with some consideration for liquidity and market capitalisation. This would be considered better than an ‘eggs in one basket’ strategy, while also giving broader exposure to the industries that may adopt different DLTs based on their specific use cases.