For all the regulatory scrutiny that blockchain and distributed finance, more commonly known as DeFi, continues to receive, government belief in the strategic importance and staying power of this technology has only grown stronger over the last few years. According to Deloitte’s annual blockchain survey, 46 per cent of government officials in 2018 believed that blockchain will be disruptive to their sector and therefore worthy of study and engagement. In 2020, 68 per cent of government officials surveyed indicated that blockchain would be a strategic priority over the next two years.
Given the track record of government and NGO blockchain pilots over the last four years, the increase in enthusiasm is driven more by the blockchain bull market rather than actual progress in adoption. Inspired by blockchain, governments are seriously considering revolutionary national initiatives to launch central bank digital currencies, or CBDCs. Regardless of whether a CBDC is issued on a blockchain, the technology will need to be core to any programme to ensure it is compatible with the wider ecosystem of digital assets. The public sector will therefore need to adjust their approach to blockchain adoption to ensure success.
Since the emergence of enterprise blockchain in 2017, governments and NGOs across dozens of countries, including all members of the G20, have undertaken blockchain pilots. The wide-ranging use cases include payments, security tokens, identity management, supply chain traceability, land registration, corporate registration, health care and taxation.
Let’s go through a few examples. In the US, the Department of Homeland Security, Health and Human Services Department and General Services Administration have piloted identity management and entitlements disbursements. The US Department of Defense has also experimented with tracing components and semi-finished goods for its supply chains. In Argentina, the government of Buenos Aires has piloted the use of Ethereum to assign a government identity to those in the poorest neighborhoods so that they can have access to government resources and start to build up credit. The World Bank and United Nations have both run several development-based pilots around sustainability and food distribution. The governments of Ethiopia, Singapore, Hong Kong, the UAE and the Republic of Korea have all completed complex, multi-stakeholder trade and supply chain pilots on blockchain to cover the end-to-end process.
As of now, none of these pilots have gone into production. Countless like them have been abandoned. Even the ones that will go into commercial use for live transactions have no plan to scale. Why the difficulty?
The consensus mechanism in blockchain is explicit, whereas it is implicit in systems based on traditional centralised databases. In practical terms, that means that multiple organisations or individuals comprising a blockchain network have to run part of the infrastructure of that network, known as a node. Blockchain technology has advanced to the point that participants in a network can share nodes or can rely on others’ nodes to keep the consensus mechanism of the network robust. Even so, such an explicit technological investment means ecosystem members have a higher threshold for participating and will demand more of a say in a blockchain system’s features, IP distribution and governance policies.
Non-blockchain government technology products already entail a long period of stakeholder engagement and consensus-building. When this traditional implementation approach is applied to blockchain, the projects become too unwieldy and slow to make it to production. The overwhelming failure of government or NGO-run blockchain pilots is testament to that. According to a 2018 US Department of Homeland Security report, blockchain pilots are still considered to be in the “research” phase because the “programs resulted in the development of blockchain very like current SQL or Oracle database programs. In some respects, using the blockchain was cheaper and created a program that was perfect for the environment or task at hand but in other cases there was no significant difference.” That does not mean blockchain should indefinitely remain in the exploratory phase. Because the technology is so new, the availability of blockchain engineering talent is so low, and the level of disinformation about blockchain is so high, the public sector must take an incremental approach rather than wait for the technology to be fully mature and all stakeholders to be satisfied.
Add to that the challenges of adopting any cutting-edge software. Blockchain systems need to be integrated with legacy systems, and government and NGO employees have to be trained to maintain and develop on top of the platforms once an outside vendor has done the initial deployment. Multi-party systems also require heavy cloud usage, and many government and NGO entities have not yet upgraded their backend to the cloud. For some perspective, AI has been designated a critical technology by most governments for almost a decade, while blockchain has yet to make the list for most countries. However, even the US Department of Defense recently admitted their AI pilots have been easy to start but almost impossible to scale.
However, there have been successful government blockchain pilots. Singapore has partnered with JP Morgan and Temasek to launch a multi-currency payments network for cross-border payments, foreign currency exchange. United Arab Emirates uses blockchain for its notary services and land registration. Its KIKLABBUAE Free Trade Zone is the first government to accept bitcoin as legal tender. The Republic of Georgia has also implemented a land registration system, perhaps the earliest production deployment by any government. Finally, numerous Covid-19-specific pilots had to go into production due to their urgency. The US used a blockchain-based 3D printing system to transform sleep apnea machines into ventilators, and China launched 20 blockchain applications last February for use cases such as screening and secure storage of health records and PPE management.
While these successes are notable, they are still relatively small in scope. CBDCs are, to date, the most ambitious and critical project governments have taken on in blockchain. As governments aspire to launch in the near future, how can they implement a system that scales?
Experiment early and often. Blockchain pilots can become far too cumbersome when the product goes through an extensive design process in which all stakeholders’ input is solicited. The government agencies running these pilots should instead work closely with their internal stakeholders first and then two to three key user groups to set the initial product features. The same process can be repeated once successive waves of user groups are onboarded to the platform. Rapid experimentation and iteration with smaller, discrete groups of users is a far more effective method for encouraging users to adopt and executing on a product that will provide true value. China has adopted this approach for their CBDC, and other countries who want their own CBDC in the near term should proceed similarly.
Another major benefit to this approach is that it allows bad use cases to be discarded quickly. Blockchain is still quite expensive as a system for data security and management, so those deploying new networks should take every opportunity to become sharper on whether the value proposition is still valid and sufficiently compelling to scale.
Ditch the consortium approach. Consortiums are necessary for harmonisation of technology standards, but they pose an artificially high barrier to product design and deployment. Most blockchain consortiums will require that a network and its applications be highly customised according to its members’ specifications. The result is a slow, contentious process that will yield a product with limited use, a rigid upgrade path and fragile governance mechanisms.
Invest in a buildable platform. Blockchain platforms will not satisfy all future needs at initial deployment, so the platform will need to be expanded and upgraded. Because so much time and so many resources go into government blockchain projects, the temptation is to build an aircraft carrier from the beginning, which only makes it more likely the pilot will not be completed, let alone move to production. Features should be added incrementally, and the new generation of blockchain platforms should have interoperability built in so that they can communicate with other networks.
Focus on the user incentive. The most successful blockchain applications, across all sectors, provide for easy onboarding and a built-in financial incentive. Remember that blockchain is first and foremost fintech. Securing or surfacing data from members of an ecosystem is a second-order use case because the financial benefit is not as clear as in the case of digital assets or DeFi. Absent a financial incentive, the public-sector organisation must have sufficient conviction to sponsor or mandate adoption by other members of the ecosystem. Land registry and digital passport solutions are examples of such government-mandated digital services. CBDCs are a financial asset and therefore should not run into this issue.
Embrace DeFi as an opportunity, not just a regulatory challenge. Both DeFi and enterprise blockchain rails can be used for government applications. Governments are far more comfortable working with non-DeFi blockchain technology because of the culture fit with the companies in this space, the absence of risky assets, controlled deployment of networks and superior data privacy features. However, DeFi models and the technologies that underlie them offer the rails with the quickest path to adoption. Governments and NGOs therefore need to consider a shift in innovation mindset if they don't want to fall behind on blockchain.