The stock market may have practically tripled its historic returns in 2017, but compared with the cryptocurrency market, it looked like a flat line. Last year, cryptocurrency market caps as a whole increased by more than 3,300%. It would have taken the stock market decades to deliver similar returns.
There were no shortage of catalysts, either, with news-driven events, partnerships, and a weaker U.S. dollar driving investors to take a chance on virtual currencies. But standing head and shoulders above these catalysts was the rise of blockchain technology.
Why businesses are so excited about blockchain
Blockchain is the digital, distributed, and decentralized ledger that's often tethered to cryptocurrencies and is responsible for recording all transactions without the need for a financial intermediary, like a bank. Its evolution is a result of inefficiencies seen in the current banking system, such as banks pilfering fees as a third party during transactions, and payments taking days to settle, especially when made across borders.
Blockchain, despite having numerous advantages, brings three critical benefits to the table that financial service companies should appreciate. First, its decentralization is important. Rather than storing transaction data at a single source or server, this data is kept on hard drives and servers all over the world. This ensures that no single entity, including hackers, will ever control a blockchain or cryptocurrency.
Second, blockchain technology works around traditional banks. This means processed transactions involve a sender and receiver of funds, but no intermediary bank pilfers a fee. The belief is that this could lower the overall cost of transaction fees for consumers and/or businesses.
Most importantly, though, blockchain offers the possibility of dramatically speeding up the settlement of transactions. Since proofing of transactions is ongoing 24 hours a day, seven days a week, blockchain could validate and settle payments in a matter of seconds. By comparison, the current banking system could take up to five days to validate cross-border payments.
Keep in mind that blockchain has applications beyond finance as well. It's being tested in varied capacity by logistic, retail, tech, and energy companies.
Blockchain spending is expected to soar
Yet what's perhaps most impressive about blockchain is how quickly spending on this nascent technology is expected to grow in the years to come.
According to a recently released report from IDC, the "Worldwide Semiannual Blockchain Spending Guide," the compound annual growth rate for blockchain spending between 2016 and 2021 is estimated to be 81.2%. After just $945 million was spent on blockchain solutions in 2017, $2.1 billion is expected to be deployed on blockchain projects in 2018, and the figure is set to reach $9.2 billion by 2021.
Not surprisingly, financial-service companies and banks are expected to lead the charge in blockchain spending in 2018, with an estimated $754 million. As a whole, IT services and business services are projected to combine for 75% of all blockchain spending between 2016 and 2021. Said Stacey Soohoo, a research manager in Customer Insights and Analysis at IDC, "2017 was the year of experimentation as enterprises realized both the benefits and challenges of blockchain. 2018 will be a crucial stage for enterprises as they make a huge leap from proof-of-concept projects to full blockchain deployments."
We certainly don't have to look far to see the scope of this potential. The Enterprise Ethereum Alliance currently has 200 members, many of which are brand-name multinational companies or government entities, testing a version of Ethereum's blockchain. Also, the financial service-focused Ripple has snagged itself five brand-name partners in less than two years.
Even Dow components are getting in on the act. IBM (NYSE:IBM) has been at the forefront of blockchain development, having partnered with Stellar in the South Pacific, and recently announcing a supply chain-based joint venture with shipping giant A.P. Moller-Maersk. IBM's South Pacific venture is designed to expedite payment settlement with a dozen banks in the region, while its joint venture with Maersk should improve logistic efficiencies and provide real-time data to senders and receivers of goods. When all is said and done, IBM's blockchain solutions may appeal to a wide swath of sectors.
IDC spending report aside, these major concerns still exists
Yet for as exciting as blockchain technology has been, it still comes with a number of clearly defined risks.
At the top of the list is whether businesses move beyond demos and small-scale projects and actually consider blockchain as a real-world solution. To this point, even major partnerships with brand-name companies haven't led to more than very narrowly defined real-world tests. As such, there's no precedent that scaling blockchain technology will work at this point. We're going to need to see companies make that leap if blockchain is to be trusted.
Second, don't overlook the virtually nonexistent barrier to entry in blockchain development. For instance, more than 600 cryptocurrencies have come to market since July 2017, and most have their own tethered blockchain. It only takes time, money, and a team that understands how to write computer code to bring blockchain and a tethered cryptocurrency to market. Today's most promising blockchain platforms could just as easily be proven inferior tomorrow, which makes it tough for businesses to lock in on a single blockchain platform.
Third, blockchain isn't always going to be the answer. While it's a great solution for resolving the banking industry's long transaction settlement times, implementing blockchain solutions in other industries may require removing existing software or networks and starting from scratch. That's a costly and time-consuming proposition for a largely unproven technology.
Finally, don't forget that investors are notorious for overestimating how quickly new technology will be adopted. Investors have regularly created and popped bubbles for decades expecting that newly developed technology would be immediately accepted by businesses when, in reality, it often takes years (or longer) for the foundation to be laid.
Though IDC's report correctly translates the excitement surrounding blockchain spending, I am not convinced that it'll equate to real-world adoption anytime soon.
Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has a disclosure policy.