The Last Mile Problem: Understanding the Economics Affecting the Future of Blockchain
Is Blockchain designed for consumers or organizations? Will it ever be an Uber-alike app built on Blockchain? What is holding Blockchain back from mass adoption to date? This article provides insights to these questions and adopts economic theory to critically analyze a fundamental challenge of Blockchain — the “last mile problem.”
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Blockchain is recognized as a new form of general purpose technology (GPT). Other examples of general purpose technology include the steam engine, electricity, and the Internet. In other words, it has the potential to affect the entire economy at the national and global level and drastically alter societies through its impact on pre-existing economic and social structures. However, the question is, why are we yet to see the impacts of Blockchain ten years after its birth? We’ll answer this question by outlining the three distinct characteristics of a GPT, namely:
- Pervasiveness — The GPT should spread to most sectors.
- Improvement — The GPT should get better over time and, hence, should keep lowering the costs of its users.
- Innovation spawning — The GPT should make it easier to invent and produce new products or processes.
Naturally, it takes time for a GPT to diffuse through the economy. Nevertheless, there is a fundamental challenge to the mass adoption of any GPT, which in our case is referred to as the “last mile problem” of Blockchain.
To understand this problem, we first need to appreciate that we are dealing with two types of assets in any Blockchain use case: digital assets such as cryptocurrency and smart contract ( bitcoin and Ethereum is a good example of such), as well as physical assets such as gold and real estate. The last mile problem of Blockchain refers to the bridge between a physical asset and its digital avatar on the chain. The credibility and effectiveness of a Blockchain solution critically depend on “the way” or “the last mile” of bridging these two types of assets.
So what’s the big deal here? Let’s look at some popular Blockchain use cases.
- Verifying food provenance is a well-established use case of Blockchain. Storing and verifying every event and the associated status data of food along its supply chain, i.e. from the plant to a supermarket is easy, what’s hard is to prove the authenticity and integrity of these status data. How do we ensure the data captured and stored on the chain are accurate and trustworthy? Also, how do we achieve that cost-effectively?
- Tokenisation is another prominent use case and application of Blockchain. The main benefit of tokenization is to improve the liquidity of asset trading. Tokenization involves digitalizing a form of the physical asset and creating a set of tokens that represent this physical asset in the digital/blockchain world. Essentially, it securitizes a physical asset to support more frequent transactions with a lower capital requirement. Royal Mint Gold (RMG) is a Blockchain-based platform for buying and selling gold. It was founded by Royal Mint, a government-owned mint that produces coins for the United Kingdom. As per its claim, 1 RMG represents ownership of 1g of real gold. This means you’ll have full ownership of your gold; the gold is stored in The Vault® at the Royal Mint. However, RMG was unable to answer the following questions: Who provides the proof that 1 RMG represents 1g of real gold? How do you uniquely bridge 1g of a gold bar with a unit of RMG? How does RMG build out trust and consensus in its system? The last mile problem again. As reported by Reuters, “ Wary of crypto, the UK government blocks Royal Mint’s digital gold.” “Royal Mint Gold was to launch in the autumn of 2017, but CME decided at the last minute to pull out, leaving the mint without a trading venue, sources said.” RMG was never in production.
Are you feeling the challenge now? How about we find a way (an intermediary or a solution) to solve this problem? You may ponder. Finally, this leads to the real factors that affect the advancement of Blockchain technology — regulation and economics.
In the Blockchain world, to mirror physical assets with digital tokens, you need to be able to link the two forms of assets legally and financially. For example, if you are going to tokenize a real estate property, the “ token “ needs to have the same legal binding as your property ownership certificate endorsed and protected by the local jurisdiction. This is the first part of the last mile challenge — how do you legalize the tokenized asset? The second part of the last mile challenge is on the financial side. Currently, the vast majority of countries have laws that require financial institutions to use depository banks for securing asset collateral. No such depositories exist for digital assets. This means there are no legal means for digital assets to be secured for use in the mainstream financial sector, regardless of the state of the technology.
A major breakthrough for Blockchain is its ability to lower two fundamental sources of cost for a business transaction — the cost of verification and the cost of networking.
The cost of verification - This cost relates to the ability to verify the attributes of a transaction. It is embedded in literally all business transactions and can be as simple as showing someone your ID card in order to buy liquor, verifying goods moving through a supply chain, or checking the full The cost of KYC process of getting a mortgage loan. Think about a world where the cost of verification is extremely low or nearly zero…essentially a costless verification. The biggest upside of that is you can build integrity into services and systems because people know that data hasn’t been tampered with and the cost of knowing that is almost zero. This is essential to the future digital world as the Internet is to the world today.
Blockchain is very effective in lowering the cost of digital verification but falls short when it comes to physical verification because of the last mile problem. Options to bridge the interface between the online and offline world can come from new types of intermediaries, for example by leveraging technologies such as IoT sensors. This undoubtedly increases the cost of verification. So, until we have a cost-effective solution to manage the friction, it will continue to prevent Blockchain from delivering on its full potential.
The cost of networking — This is the cost of establishing and maintaining a business relationship and ecosystem.
Blockchain technology allows a network of economic agents (e.g. individuals, companies and devices) to agree, at regular intervals, on the true state of shared data. The fact that shared data can represent any form of digital assets and state of events makes Blockchain a general purpose technology (GPT). This essentially reduces the “market power” of intermediaries by allowing individuals and organizations to transact with each other. This is possible because trust in the intermediary is replaced with trust in the underlying code and consensus rules.
The cost of networking can be broken up into two parts:
Part A: The cost of establishing the network
Let’s use a hypothetical example to illustrate this concept. a blockchain powered “Facebook” called “Blockbook” to explain this. Let’s say unlike Facebook, Blockbook has a unique service proposition (USP) in that it gives individuals full control of their own data and privacy; it even offers users the option to monetize their own data. Also, the cost of verification is nearly zero. Will it be successful? I doubt it very much since the very problem Blockchain resolves, i.e. trust, is not valued by mainstream consumers so much and surely was not the reason behind the success of Facebook. When a user opts in or out of an app, what he cares the most about is the experience and cost. Privacy and trust are essential, but the experience and cost take precedence. Moreover, users expect that for free. The saying, “When you are getting a product for free, that means you are the product” is an apt description of what takes place in this scenario. This phenomenon is undoubtedly not a Blockchain problem, and neither can it be resolved by blockchain.
Part B: The cost of maintaining the network
What about organizations? Surely they value trust and user privacy a lot. Blockchain can surely lower the cost of maintaining and operating the network once it is established. However, the reality is that building the initial network is a very time-consuming and expensive process which often requires firms to collaborate or form a consortium. According to Deloitte, “A recent study counted some 61 blockchain consortia across a dozen industries globally-significant growth versus the prior year”. This highlights how the success of Blockchain very much depends on how effectively you can forge an ecosystem/network. Not many organizations can do that well today.
Let’s answer the questions mentioned earlier.
Is Blockchain designed for consumers or organizations?
With a few exceptions, i.e. blockchain in the video gaming industry, blockchain is more likely to blossom in a B2B model given the propensity of enterprises to pay for resolution and optimization of a “trust”, “security/privacy” problem and situation.
Will it ever be an Uber-alike app built on Blockchain?
Unlikely, in a true blockchain-centric fashion, i.e. DAPP in the near future. Understand that blockchain is like chili sauce — there are a lot of areas you can add a little splash of blockchain to, and end up making a much better and more compelling solution. Using blockchain as peripheral layer technology to enhance user experience and to reduce cost will go a long way. (For more details on how to evaluate a blockchain use case, please refer to chili sauce evaluation framework )
What is holding Blockchain back from mass adoption to date?
The last mile problem is undoubtedly a key factor.
At the interface between the digital (online) and physical (offline) world, the usefulness of Blockchain technology depends on intermediaries to effectively bridge “the last mile” between a digital record and physical assets, businesses, devices or events. However, Blockchain is not about removing intermediaries, instead, it is about reshaping how business transactions are being managed. Although it does this really well with digital assets, managing physical assets is still a tall order. On the flip side, it reveals a rare innovation and business opportunity to start-ups and organizations to resolve this problem and to create extensive margins — new applications in the marketplace that would make it possible to offer services that could not have been offered without the new solution.
Originally published at https://www.datadriveninvestor.com on April 29, 2019.