Blockchain applications: hype or reality?

SMU Office of Research and Tech Transfer – If you’ve been following banking and investing over the past decade, you’re probably familiar with the “blockchain”. Often mentioned in connection with Bitcoin, you may even think they are synonymous or use them interchangeably, but they are not the same. Blockchain is the technology behind Bitcoin; Bitcoin is just one of the many applications of blockchain technology.

So what exactly is blockchain technology?

“Blockchain is a cryptographically secure ledger. It maintains a reliable, sharable and timed record of transactions, ownership and rights,” explains Professor Qiang Cheng, Dean of the School of Accountancy at SMU.

“Although cryptocurrencies are the best-known applications of blockchain, companies and governments have initiated or plan to use this technology in other areas, such as traceability of products by e-commerce companies, registration of ownership and keeping of registers by local governments and the processing of capital transactions by the Australia Stock Exchange. ” Professor Cheng is currently evaluating whether the use of blockchain generates value for users.

Document the value of the blockchain

Blockchain has garnered a lot of attention over the past decade because the technology has been evident in reducing risk, eliminating fraud, and bringing transparency in a scalable way. It was developed specifically for Bitcoin in 2009, but has since been leveraged to drive innovation and increase efficiency in new domains like real estate, healthcare, and politics. Some people believe it has the potential to change systems across all industries for the better, while others say it’s just an advertising campaign.

“It is not clear at this stage whether nascent technology generates value for companies,” says Professor Cheng. “This is why our research is so important and timely.”

Given the cost of implementing blockchain technology and limited talent in this area, Professor Cheng believes it is crucial to empirically document the economic value of blockchain applications. “To our knowledge, there is no academic publication that provides a rigorous empirical analysis of the economic value of blockchain applications in a commercial environment or in financial markets.”

Professor Cheng recalls his conversation with an e-commerce company in China that had started using blockchain for Asset-backed Securities (ABS). “They weren’t clear about the true value of the technology. They were using blockchain because it was new and therefore trendy, and because they have already developed the technology.”

Professor Cheng and his team, consisting of Lee Kong Chian Professor of Accounting Xia Chen (Co-Principal Investigator) of the SMU School of Accountancy and Associate Professor Ting Luo (Collaborator) of the Department of Accounting at Tsinghua University, recently received a Tier 2 Scholarship from the Ministry of Education Academic Research Funding (AcRF) to study the value of blockchain applications in the financial market. As one of the first projects to do so, Professor Cheng is convinced that whatever the results are, they will be important for organizations like the Chinese e-commerce company, as well as for governments that are harnessing the economic impacts of technology.

The basis of the research

ABS was chosen mainly for practical reasons, says Professor Cheng at the Office of Research and Tech Transfer: Researchers collected data on securities in China that used blockchain and those issued without the use of blockchain. “It allows us to check whether ABS issued via blockchain technology are valued differently by the market than those that are not.”

ABS are debt securities with interest and principal payments backed by a specific pool of underlying assets such as mortgages and credit card loans. It suffers from shortcomings such as information asymmetry and credit rating inaccuracy and agency issues – the two issues that Professor Cheng is investigating in ABS issuance.

The researchers compare the return on ABS (the interest rate paid by the originator) and its cost of issuing. “If the blockchain really has positive economic benefits – by reducing the asymmetry of information on the economic value of assets – then it should result in a lower return and cost of issuance, since the symmetry of information is the most important factor for both variables”, says Professor Cheng.

“The results will be important for market participants involved in both issuing and buying ABS because issuing ABS with a lower yield and lower issuance cost is beneficial to all market participants.”

Information asymmetry in transactions is a situation where one party has more or better information than the other, creating an imbalance of power in transactions. Professor Cheng believes that issuing ABS via blockchain can effectively address information asymmetry. Compared to traditional ABS issuance, blockchain-based securities have all the underlying assets recorded on the blockchain where market participants have access to the ledger.

“The trustee, the law firms and accountants, the underwriters – they all have the same set of information as the originator. There is transparency and therefore a greater ability to assess the quality of the underlying assets.”

The use of the blockchain also reduces the reliance on third-party verification of the quality of the underlying asset. To reduce the information asymmetry, originators rely on a third party, such as rating agencies, to assess the quality of the underlying assets. However, third-party verification can only reduce information asymmetry to some extent, as it only assesses the quality of a random sample of the underlying assets provided by originators. Additionally, sellers pay for third-party services, leading to agency issues such as inflated ratings or rating purchases.

The hypothesis is that since information asymmetry is a key determinant of the yield and cost of issuing ABS, blockchain can reduce its yield and cost of issuing. ‘Our preliminary results show this to be true: the interest rate or return on ABS issued using blockchain appears to be lower than those using traditional means,’ says Professor Cheng.

Relevance to Singapore

In collaboration with Temasek, the Infocomm Media Development Authority (IMDA) and the Monetary Authority of Singapore (MAS), the blockchain technology company ConsenSys has published the “Singapore Blockchain Ecosystem 2019” report on the use, investments, legislation and policies on blockchain applications in Singapore. The report describes the ambition of the private sector and the government in developing blockchain technology. Singapore is expected to see an annualized 32.5% increase in the size of the blockchain market from $ 201 million in 2022 to $ 1,889 million in 2030. Actual growth will be affected by the perceived value of blockchain applications.

Both companies and government agencies in Singapore are actively investing in blockchain technology and studying its applications, says Professor Cheng. For example, 1exchange (1X) has obtained approval from the MAS to manage its private stock exchange. It is the first regulated private stock exchange built on a public blockchain. Given the early stages of these applications, its value remains to be seen.

Due to the cost of developing and applying blockchain technology, understanding the economic value of applying the technology in various areas is critical. Namely: the return on investment to justify the implementation of the blockchain, says Professor Cheng. “To that end, the evidence in this project can contribute to the debate on the value of the blockchain. The evidence of positive value can certainly fuel greater interest, investment and growth in the blockchain market in Singapore and beyond, and vice versa.”

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By Grace Segran