2 November 2015

Blockchain Technology and the “Just in Time Money”

The success of Bitcoin1, the virtual crypto-currency, is based on many technological innovations. The most important being the concept of consensus based distributed ledger of transactions, known as blockchain.

The fact that blockchain is synchronized across multiple nodes and new transactions are added based on consensus of the majority, takes away the need to have a centralized trustworthy counterparty such as a bank (for monetary transfers) or a depository firm (for shares and bonds) or a registrar (for land records), and so on. Distributed nature of this ledger makes it significantly more secure than a centralized database. (However, we have seen recurrent evidence of a tendency among operators in this area to attempt to extract rent by offering “convenience” of a wallet, thereby centralizing some of the operations and hence negating the security benefit. In order to fully benefit from blockchain, this should be eschewed.)

Combined with other rapidly evolving technological advances such as low cost of communication and computation, ubiquitous internet and smartphones across nearly all urban human habitats in most of the world, it is possible to imagine that blockchain will disrupt not only the payment and settlement systems, but also the working capital arrangement of a commercial society. Enough is being said on the potential to disrupt the payment and settlement system by other observers, hence we will concentrate on potential impact of blockchain on working capital arrangements.

We are all aware of the effect of “Just in Time” inventory concept popularized by Japanese on the production costs and on the flexibility of production process. It is possible to have the same effect on efficiency of working capital management of the society through effective use of blockchains in conjunction with other technological advances.

Consider a few examples. Most of us pay rent or mortgage installments on monthly basis, while we enjoy the benefit of the property on continuous basis. This means that landlord has to have one months’ of working capital if the payment is in arrears. It is now possible that the payments can be constructed to go out on daily basis. Similarly salaries and wages can be paid daily, utilities can be metered and paid daily, and so forth. At the other end of the spectrum, a container ship can be paid based on miles sailed each day by the consignors.

The increase in payment frequency will lead to efficient utilization of working capital in the society and lower incidence of bad debts and disputes. As Adam Smith had implicitly understood well, unitization and standardization of commercial activities lead to greater efficiency gains for the society, far beyond reach of any commercial enterprise. If implemented properly, Blockchain Technologies have the same potential to revolutionize the payment, settlement and working capital management systems of the society.

1 This author is no fan of Bitcoins. That concept always smelt and felt like Tulip Mania. We are discussing here one of the technology behind Bitcoins, and its applications to broader concept of money.