The Private Equity for Families Blog

Disrupting Trust and Validation Business

When Luca Pacioli introduced double entry bookkeeping in the 15th Century that single idea spawned acceptance of the modern corporation as a vehicle for collaborative business because it created an auditable trail of financial entries. The third party trust and validation business was soon to follow and has blossomed and grown ever since.

Until I read the July 15 issue of The Economist I had never thought about what a big part of the world’s economy is devoted to proving ownership, validating compliance, keeping a perpetual record and managing lists.  “The Long Arm of the List” by the editorial board of The Economist points out that blockchain technology may disrupt a huge part of world GDP.

Validation Is A Huge Business

Now you find validation business everywhere; real estate title agencies, accounting firms, vehicle license bureaus, corporate trust companies, forensic auditors, notary publics, depositary trust corporation (“DTC”), Federal, state and local permits, product warranty registrations, Visa, Amex and MasterCard, art auction houses, central banks, commercial banks, international passport control, chip readers, password protectors and birth certificate . These businesses thrive by managing the complexity of validating credit, ownership, title or identity. They are the foundation of an integrated world of commerce and they are indispensable for now. They are also massively expensive, but worth the cost.

The Cost Of Friction Is High

Imagine a world where you only paid pennies for a real estate title search (now $80 per transaction), or a real estate title policy (now $300 per house transfer). Think about a ledger keeping community for the entire stock market and bond market that is paid in ETF units to validate every single change in ownership and is not owned by Wall Street. Think about an independent registry for collectibles and precious gems that is 100% accurate in proving a real Monet and the identity of the Hope Diamond. Think about not having to rely on bureaucrats for licenses and permits. What if you did not need Visa, MasterCard or American Express to vouch for your credit? According to The Economist, and many other futurists, the blockchain technology that underpins bitcoin may threaten to disrupt all these expensive third parties.

Computing Power and The Distributed Ledger

To understand the blockchain technology I use the analogy of real estate titles. It is possible to search the ownership of some pieces of property in England as far back as 1066. So if you are a Australian retiree who wants to buy a country farm in Essex, you can hire a title examiner to look at the ownership ledger for that specific legal description going back to the first owner. For a fee the title examiner validates the seller’s chain of ownership and ability to convey clear title to the Aussie retiree.

The blockchain technology does the same thing for every bitcoin transaction by researching its title back to the original issuance. According to people who really understand the underlying technology and business model, it can be adapted to validate anything with a unique signature. That could be a fingerprint, gem coloring, an artist’s signature, a CUSIP number, an iris, a bank account or a digital currency. The business model or rules for the community that is utilizing the blockchain technology can be customized to the particular industry.

For example, bitcoin only has two signatures. It has a receiving account number that is used to receive and hold bitcoin. It also has a super secret sending number that allows any party who has the sending number to transfer bitcoin from the holding account. Successful hackers must have both numbers to steal your bitcoin. It is almost like a bearer bond that is ripped in half and must be reunited to trade. Crooks can’t bribe someone to validate a theft because the ledger for every bitcoin transaction is distributed among thousands of independent “miners” whose computers compete to validate every single transaction. If one miner is ready to approve a heist but there is no match of sending and receiving numbers, 40 other computers will not validate and the transaction will not be approved. The miners are also paid in bitcoin so they have no incentive to undermine their own currency.

Will New Business Models Emerge

The same concept may work for gems, stock and bond ownership, bank and trust accounts, licenses, permits and even databases. What if database giants like Facebook, Amazon and Google did not have a complete record of your friends, what you buy and what you are searching on the web? It certainly would be a lot more private. Blockchain technology also has the potential to disrupt powerful incumbents like governments. The editorial board of The Economist questions whether politics will stop the distributed ledger:

“Each time we use a distributed ledger we participate in a shift of power from central authorities to non-hierarchical and peer-to-peer structures.”

While for profit incumbents will keep trying to discredit this new technology and politicians will find ways to legislate against it by predicting massive job losses and disruption of the current order, technologies like blockchain that can cut costs and simplify and protect consumers always get adopted in the long run.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records Founder and chairman of CapitalWorks, he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CapitalWorks or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.

Private Equity for Families Blog | CapitalWorks Private Equity Cleveland Ohio

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