Blockchain business model design

This article is the summary of a one hour podcast with Insureblocks in which Walid Al Saqqaf and I discussed the principles of blockchain business model design based on what I have learnt over the last 2 or 3 years working with close on one hundred networks in their very early stages of start up. This article is summarised in a collection of short video blogs here.

What is different about blockchain business models?

Private permissioned blockchains initially focus on optimising shared business to business processes. Up to now the approach businesses have taken was in having a central intermediary to act as a central database to smooth out that shared process. The challenge is that both the quantity and the value of data has been growing very rapidly, leading to reluctance in businesses to share that data to a central intermediary, for example players in a supply chain not wishing to share data with a control tower.

Blockchain gives us a super elegant approach to sharing this process and data across the members of an ecosystem in such a way that no one person is in charge of the data. All the members can have a say in how that data is governed and those involved in consensus each have a full copy of the ledger. Smart contracts are running on top of it and that is where the shared processes have been codified – who needs to do what to move the status of an asset as it moves across that shared process as trades of ownership of that asset are made. When a trade of ownership transaction is proposed to update the ledger, a consensus mechanism is used, so that all the members of the network can come into agreement as to what is the status of this asset as it as it moves through this shared process.

Blockchain has created a new asset which is shared & trusted data at the level of the market. Privacy controls are put into place so that only the permissioned individuals are allowed to see the data. This new asset is effectively the foundation stone to truly innovate, to create new types of business and new types of marketplaces.

This paradigm shift provides players within an ecosystem an interest to collaborate with their competitors in building that trusted data marketplace to then compete above it whilst injecting your firm’s private process capabilities and combine it with that trusted data.

Building business cases for blockchain

There are three big areas where building a business case for a blockchain network is different than any other technology:

1. Incentive model
2. Network effect
3. Market level thinking

For any blockchain network you also will need an effective governing body that plays the role of defining the marketplace rules. It needs to be fair and democratic to ensure that everybody gets a fair chance and cut of things and a desire to increase the volume of transactions within that market.

Incentive model

Three different types of business cases have to be built to create an incentive model. Each of these business cases have to interrelate and create reinforcing behaviour:

1. A solid financial incentive for whatever entity who is going to be bring this network to market.
2. A strong business case for each of the members of the network to join it. If members benefit greatly from the network you charge them a fee to use it. Some members may be so valuable to the network that they either have great gravitational pull that they can bring other members to the network or whose data is so valuable that you may choose to give them free access to the network.
3. The final case is for those who provide useful data (including decisions) to the network but don’t benefit greatly from being in the network. An incentive model is required for them to join and use the network.

Network effect

The whole point of the incentive model is to ensure that most, if not all, of the trading partners of a market join a blockchain network. The incentives are here to identify and recruit the partners who can bring the most transactions and volumes to the network in order to seize a market. This will in turn enable to help all network participants to innovate on top of that new marketplace.

Network effects here are not like a Facebook model. With Facebook you have a single governing identity that is controlling the data. In a blockchain network there isn’t one party that is owning and driving the governance and monetisation of the data.

Market level thinking

The third point regarding blockchain network is to be thinking at the level of a market. These markets will be driven by zones of regulation, for example one in the EU, one in the US and one in Asia Pacific. Because these are networks for businesses they need to be compliant to the local regulation.

Effective governance

The governance is all about designing an incentive model to drive helpful behaviour from all of the various interest groups on the network to drive the volume of transactions up through the network. It’s critical for a governing entity to be fair, where every participant has a fair incentive to want to join and get a fair sharing in the benefits of being part of that network.

If that is achieved we need to make it as simple and as easy as possible to move a business onto the blockchain network. That is why we need to start with a very thin layer of blockchain that initially focuses on the shared processes to automate the paper processes, the phone calls and Excel spreadsheets. Additionally, it has to be commercially attractive to join the network, it has to have an easy onboarding and immediate first benefits, making it easy to consume the service.

An example of the importance of having a good effective governance model is through a case study of 31 banks in Australia who created a financial network together.

The top three or four banks in the network probably have something like over 50% of the market share. The aspirations these banks had was to create a marketplace utility. They engaged with the local regulator who made it clear that the 31st bank that signs up to the network isn’t disadvantaged compared to bank number one. The governance structure used to regulate that network was made to ensure that all banks weren’t disadvantaged when joining the network compared to the original founding ones.

5 Rules of blockchain business model design

The 5 rules of blockchain business model design represent five core rules one needs to consider when building a blockchain business model.

Rule 1: Network entities sell digital products and services on a marketplace created through ecosystem collaboration

The first law is about creating new digital products and services. And we’re looking to expose these on a marketplace.

Don Tapscott mentioned at Consensus 2018 that we were seeing the birth of a new type of business that looks more like a network. There are numerous special purpose vehicles for creating a blockchain network. In one market a for profit company may be created by the four or five founding members to take this network to market. Other markets may take a different approach such as using a non-for-profit consortium. An alternative approach is one where a new market entrant, working with a technology solution provider who is building the capability, takes this value proposition to market and builds an ecosystem around it. The fourth model is one where you have a dominant player within a market who chooses to launch a blockchain network. This is the easiest and fastest approach to launching a blockchain solution.

According to the 2nd Global enterprise blockchain benchmarking study, 71% of live networks have been initiated by a single founder leading the initiative.

In all instance it is critical to have a governing board that will fairly represent the interest of the key players in the market.

Rule 2: Platform revenues increase with network effects within one market or by building new markets with new data combinations

The revenue line of the network economy grows exponentially with network effects. The platform will monetise all activity such as: access digital products and services, execute transactions or the buying and selling of data and insights. Network effects are created by either picking up existing trading and capturing that in a marketplace, or by creating new types of trading. Blockchain networks provide the opportunity for creating new trading relationships by bringing in new data and new member types into a new type of network driven by ecosystem collaboration and shared benefits. This drives new types of transactions. It has a governance model that ensures that everyone can govern their data and that the marketplace works on democratic and fair principles.

In creating a marketplace for peer to peer trading there are two models:

• “As is model”: These are existing peer to peer trading relationships that are added to a blockchain marketplace to put onto a shared process to automate and reduce friction caused by ecosystem reconciliation of data. This is about creating the foundations to reinvent the industry in new markets.
• “New market models”: creating new types of trading relationships with new types of data combinations. This can be done in two ways. One way is to start with a blank sheet of paper that brings member types that wouldn’t normally trade together to create a new value proposition. A second way is to take the “As is model” and inject it with some new data to drive new trading relationships to drive some new network effects.

Rule 3: Governance of incentives creates helpful reinforcing behaviours

The third law is about having a governance model that creates a fair incentive model for all the marketplace participants. Theses incentive models can take the form of cash or more elegant solutions (such as use of a utility token) to generate a helpful behaviour for all participants.

There are a set of levers a governance function can pull to design the incentive model:

• Operational improvements participants get by being part of a blockchain network
• New revenues for new market models
• Share of the revenue line for the Networked economy

In terms of how the platform value may be shared across members

• For a for-profit model you could have the rule of five, where the first five members who are starting to form the marketplace may have slightly higher privileges that the second and third set of five members in terms of equity ownership of the business for example
• For a not-for-profit model you could still follow the same sort of five by five but the first five who are putting some money in their pocket to help build out the marketplace will get access to some privileges. For example, if an innovative new service is going to be added the founding members will get exclusive access to that service for a period of three months before the other members. Or perhaps they will get a lower access to the cost of the basic services of this marketplace for a period of time until they get their money back.

Rule 4: Governance enables transition from a central start to a fully decentralised marketplace

In order for a marketplace to grow it needs to get progressively more decentralised to do that, because there’s a power equation here. If the network remains too centralised within the hands of too few people, this restricts access to the governing function, so then the incentive to collaborate starts to fall away. Finding the right level of decentralisation can be tricky and can be different depending on the marketplace.

Joe Lubin who stated at Devcon 5: “But I think it is short-sighted when some people believe that all blockchain systems must be fully permissionless and maximally decentralized." (edit I like the idea here of a range of decentralisation but I take Richard Gendal Brown's point in the comments section)

In a private permission network, the opportunity is to seize a market. For that to happen it is ideal to have the main players of that market join the network leading to an early centralised approach to that network. The key thing to determine here is how important is that long tail? If it is important, you will need to have a governance structure that is open and fair enough to incentivise new members from that long tail to join the network to seize that market.

It is thus important from the get go to determine the level of decentralisation the network wants to aim for. Will it have a coopetition model that is open to competitors joining and to the launch of new competing value propositions.

Rule 5: Governance enables the Token or Network Economy of buyers and sellers of data (digital assets) and trades of ownership

Tokens are part of the new set of tools and techniques that a governing function can take advantage of for driving trade and for driving collaboration. Tokens have three high level jobs on a blockchain:

• A means of payment whether it is in fiat or crypto
• Ownership whether it is for a digital asset or a physical asset that needs a digital twin
• Utility token

Utility token

In creating a marketplace that will have a whole range of service, you need to attract a number of participants in order for them to transact correctly onto that marketplace. What are the tools a governance function can have to create a really smooth marketplace to try to encourage behaviours right at the beginning?

Outlier Ventures have helped to inform this view on the function of utility tokens as an economic level for the governing entity to control marketplace behaviours. There are three levels that need to interact:

1. Marketplace level – encourage participants to consume services on the marketplace
2. Ledger level – encourage participants to build innovative new digital products and services
3. Governance level – design the economic model behind the token. This is useful for controlling behaviour where mining tokens or staking tokens are commonly being used in todays networks.

#blockchainthoughtfortheday

Credits

[1]: Shahrzad Pakgohar for third quote in banner heading

[2]: Outlier Ventures regarding utility tokens

[3]: Based on an interview podcast with Insureblocks and the summary writeup

[4]: Don Tapscott for the chart on Rule 1