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Needham Insights: The Blockchain Report

Needham & Company, an investment bank and asset management firm, has released an expansive document, The Blockchain Report: Welcome to the Internet of Value. The report explains what the blockchain is, how it can be implemented, applications and growth events, investment opportunities, and many of the top companies in the space.

The fundamental point presented in the document is that, "in the same way that the Internet enabled permissionless innovation for all things regarding information exchange, so too do public blockchains enable permissionless innovation for all things regarding value exchange." Because a public blockchain doesn't have any central authority, its ability to act as a completely open protocol for the transfer of value is comparable to how information was transferred once TCP/IP went mainstream.

But value is not just currency, as many are inclined to propose when discussing bitcoin. Multiple new applications have been developed targeting all aspects of the financial sector as well as cybersecurity. Due to limitations in Bitcoin, new technologies for public blockchains have emerged that compete with and complement the Bitcoin blockchain:

  • Alternative blockchains: This is an entirely independent chain, such as Ethereum, and also includes private, permissioned or federated blockchains. The writers believe it is unlikely that another open payment network will supplant bitcoin, but recognize that there could be use cases where an alternative blockchain is sufficient.
  • Colored coins: These utilize the Bitcoin blockchain, but represent assets that are not currency. These are fractions of bitcoin (satoshis) that can carry value, such as shares of stock, but remain limited to the functionality of the Bitcoin blockchain.
  • Sidechains: A two-way communication connection between the Bitcoin blockchain that utilizes the network effect and security of Bitcoin, but uses different scripting languages and capabilities of an alternative blockchain.

Bitcoin has seen a significant increase in usage. Daily unique addresses used have increased from 67,476 in 2013 to 226,422 in 2015. The average number of daily transactions has increased from 53,805 in 2013 to 112,275 in 2015. The estimated total transaction volume in 2015 is approximately $195 billion.

Other Applications

There are a multitude of different applications beyond just the transfer of value. These include:

  • Settling of assets other than digital currencies: Consulting firm Oliver Wyman estimates that the added costs, delays, points of failure, and vulnerability for trading a digital security, such as stock, adds $65 billion-$80 billion in costs every year. The idea is that T+3 can be removed when assets can be traded instantly and the data shared among all counterparties immediately.
  • Digital Asset Ownership: Proving ownership of assets on the blockchain and issuing new ones. The recent examples of this are Digital Asset Holdings helping Pivit issue a percentage of its latest funding on the blockchain; Nasdaq Private Markets is leveraging the technology for trading of private market securities; Chain will be issuing its own pre-IPO shares on the blockchain; and issued a $5 million bond on the blockchain.
  • Smart contracts: Agreements can be reduced to code that self-executes and self-enforces. Three examples that are proposed are multi-signature transactions, which involve a third-party escrow agent; prediction markets where the outcome of the prediction automatically releases securities (Augur is an example of this); and oracle services, which are third parties that verify the outcome of events. All machine-to-machine communication (M2M) could utilize smart contracts to minimize the need for human intervention.

Growth and Hurdles

According to the authors of the report, there are multiple drivers required for blockchain technology to succeed and multiple hurdles to overcome.

The primary growth drivers are adoption by major enterprises, the Internet of Things, increased consumer interest in personal data security, clear regulatory guidance, and emerging markets. On the last point, the largely unbanked, mobile-friendly markets might find the technology particularly compelling.

On the other hand, there are numerous hurdles that can impede the growth of the technology, including prohibitive regulation, broken trust - such as with Mt. Gox - and technical debates, like the current debate regarding the block size increase for Bitcoin.

Capital Formations

According to the authors, the amount of capital raised has increased significantly year-over-year. In 2014, approximately $350 million was raised by blockchain-related companies. In 2015, as of the writing of the report in October, $469 million was raised by blockchain-related companies. Further, the average deal size has increased from $3.8 million in 2014 to $8.4 million in 2015.

The most capitalized firms are 21 Inc. with $121 million, Coinbase with $107 million, and Circle with $76 million. Many of the most famous entrepreneurs and investors have invested in the space, including Reid Hoffman, Peter Thiel, Marc Andreessen, and Tim Draper, along with 7 of the top 10 venture capital firms of 2014. Further, many traditional financial institutions such as Goldman Sachs, UBS, NYSE, USAA, Barclays and Visa have invested in the blockchain space.

The authors end their report with company profiles on the most compelling companies, including Abra, Factom, itBit, Uphold, and Xapo.

Read the whole report from Needham Insights online.

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