April 15, 2022

Blockchain technology:
Was Crypto just the beginning?

Guest: Tariq Siddiqi, CFA, Senior Research Analyst at Eagle Asset Management

In this episode of Markets in Focus

Where is blockchain technology right now? Think of the internet in the late 1990s: There’s worlds of potential to transform the economy, but also every kind of practical question to be figured out. Matt Orton, CFA, Chief Market Strategist at Carillon Tower Advisers, talks with Tariq Siddiqi, CFA, Senior Research Analyst at Eagle Asset Management, about how the blockchain isn’t just for cryptocurrency, what makes it a candidate to revolutionize entire industries, and why investors should look at it as a long-term driver of secular growth.

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Matt Orton:
“Blockchain” has soared into the popular lexicon as cryptocurrencies have gone mainstream. And to many individuals, it's still viewed as a sophisticated and somewhat mysterious technology that allows cryptocurrencies to change hands online without assistance from banks or intermediaries. But in recent years, it has commanded significant institutional investment as a solution to business issues, ranging from fraud management, to supply chain monitoring, to identity verification. However, despite the hype until very recently, blockchain's use in business has remained largely theoretical. But we're now at a transition point where the costs of implementation are coming down, returns are clear, and technical difficulties are being overcome.

As blockchain deployment becomes less complex and expensive, how should we as investors be assessing the potential investment opportunity? Which sectors and industry stand to benefit the most from this transition? Today I have Tariq Siddiqi, Senior Research Analyst at Eagle Asset Management, back on Markets in Focus, to help us explore these questions with a particular focus on the information technology sector. This is Markets in Focus, from Carillon Tower Advisers. I'm your host, Matt Orton. Join me and my colleagues as we discuss the latest trends and developments driving the markets. Visit us at marketsinfocuspodcast.com for additional episodes and insights. Tariq, thanks for joining us again today.

Tariq Siddiqi:
Yeah. Great to be back. Thank you.

Matt Orton:
Excellent. So, let's start with the basics. Maybe let's start with what is blockchain and how is it most commonly used today, both within and outside of crypto?

Tariq Siddiqi:
Yeah. So blockchain technology, simplistically speaking, is a list of records. A ledger basically of transactions. Each block in this chain is basically data from various transactions, timestamps, and new information. What this basically does is that it creates a record that has all previous transactions and timestamps. So, it became resistant to modification. You can't really change one block of this transaction ledger without messing every other block that comes underneath it. Blockchain records are generally decentralized as there is no entity, or government, or financial institution that manages it. Once set up, it is auto-managed and could be a public network. So anyone can see what transaction happened at exactly what time, or it could be a private network based on permissions and rights, et cetera. So the main problem in the digital world is that you can easily replicate a file or data, and there's no distinction between those two items.

However, with blockchain, each time a file is copied, or shared, or downloaded or whatever you do with it, a new one appears. It is distinct from its source and that is what is so special about blockchain technology. It allows for that distinction, and thus now the world can differentiate between two files or, in this matter, really, transactions that look the same. So the first major use of blockchain technology has come in digital currencies like a Bitcoin, Ethereum, and a whole host of other currencies that have popped up. Individual coin ownership is recorded in this digital ledger, the blockchain. And then when that transaction occurs, the coin’s record moves to someone else with a timestamp, et cetera.

Simplistically speaking, the cash you have in your bank account doesn't actually sit there, right? The bank has very complex and sophisticated ways to manage that cash that comes in, goes out, without any paper actually sitting in a vault somewhere. In this scenario, you have a bank that manages that and rules set up by the federal government and insurance like FDIC, et cetera, et cetera. In a crypto world, without a central authority, you need something to validate who actually owns what coin, what they did with it, how much of it, and what transactions that came afterwards and so forth. And when they sold that coin, perhaps. For all that to happen without a central authority, you need a blockchain technology type of an application. And that's where it comes in.

Matt Orton:
Gotcha. That certainly is helpful to establish that base understanding. And so if we build on this, what are some of the key business application advantages of blockchain, and what do you think has been holding companies back from more fully embracing the technology?

Tariq Siddiqi:
Yeah, I think fundamentally beyond crypto, blockchain technology really promises quite a few benefits that still need to be hashed out for wider adoption. Just as a point of view, blockchain technology and the cryptology that goes behind it has been around since, call it the 1980s onward. But the technological capabilities that are required for mass adoption have only come about in the last decade or so. And Bitcoin was really just a theoretical paper in 2009. So it would be silly to expect companies to jump into a massive change in how they operate in something as fundamental as transactions and money. It'll take time, but they are evaluating it and dipping their toes as they see the need. So as opposed to talking about specific end cases right now and business applications, we'll talk about that a little bit later I think. I will point to the major points about blockchain that really make people excited. Have about seven or eight points about blockchain that are very interesting that make it exciting to people like myself.

So the first thing that blockchain brings is trust. Without a central person, it's hard to have trust between two people. Blockchain allows trust without a central person. You and I can transact without a credit card company, or a bank, or a government to protect either side. Second thing is a decentralized structure. As we just talked about, we have a system, there is no central actor. This works not only trying to reduce the cost and increase the speed, but also in areas where it's hard or impossible to have a central actor. For example, in a global supply chain for a complex product, you might have hundreds of suppliers supplying thousands of parts, and all have to certify if the individual part is say, for example, free of a certain chemical. Without a certain authority, this becomes very cumbersome and a slow process and maybe even an impossible process. With blockchain technology and a decentralized structure, this can be accomplished and done a lot faster and a lot cheaper than a lot of traditional methods.

No. 3, security. As we talked about, no one can really alter the record of transaction, and thus any changes are automatically documented and can be questioned if needed. Blockchain is stored on a network of computers. So no one's server going down, or a data center going down, or getting hacked can create problems. And No. 4, costs. Given the massive systems we have now, blockchain technology applications are quite cheap to build. And when you remove the friction that comes from central authority like government, bank, or a third-party vendor, the cost can be significantly lower. A whole lot of manual processes are removed, and that adds another layer of cost savings. No. 5, speed. Blockchain transactions happen in seconds. You have removed intermediary who has to verify and thus take their cut and have gone to a massive blockchain-based network.

And as long as that internet speed is good, the transaction can be recorded in seconds. One famous example that decided for speed is when a large retailer implemented a blockchain-based tracing technology to trace a source of their mangoes in their stores. The process used to take seven days before, and with blockchain technology, it went down to just a few seconds. No. 6, visibility and traceability. In a world where we want to know where our food is coming from, for example, or where our products are being made and what the environmental impact is, blockchain technology is a very good way to trace those things. This could be within the enterprise, like the retailer example with the mangoes or a diamond miner that uses blockchain technology to make sure they can answer questions about where a certain diamond was mined, who mined it, when it was mined, what jeweler was it sold to, and what the jeweler did with it?

And then to the retail channel, even down to the end consumer and perhaps even when that consumer sells it back to the store to upgrade to a different item. The whole entire process can be visible and traceable through blockchain technology. No. 7, lack of errors. Because it doesn't change, blockchain technology allows for no errors. Unlike some paper-based systems and legacy computer systems or files can get corrupted, and entire hard drives get hacked or erased, there are no errors in a blockchain system.

And lastly, tokenization. This is an interesting concept in that we have taken a physical item and created a unique digital identity of it. This has taken off in the digital art world with lots of non-fungible tokens, NFTs, being traded. Digital art is a perfect example of needing something to verify that this file is the only copy. For too long, digital art had the problem: the right-click and save. Now with tokenization, each copy of that file is a unique individual item. And with that comes authenticated ownership and thus tokenization allows for all that to come with ownership, such as trading, sales, resales, portfolio, et cetera, et cetera, et cetera. So there's a lot of different, very, very positive aspects of blockchain that people are very excited about in this space.

Matt Orton:
I knew we could count on you to keep things very brief with eight different points for blockchain, but I'm still wrapping my head around the mangoes and the diamond mine. And perhaps, as I think about one of the pervasive issues that's out there, which is inflation, cost inflation, and wage inflation, it seems like there's an opportunity here using blockchain to help eliminate some of those sources of inflation or at least be able to better control margins. And is that accurate? Do you think that's something companies are looking at and assessing with blockchain technology?

Tariq Siddiqi:
Oh yeah. Absolutely. I think people are definitely looking at the ways of cutting costs and reducing costs to be able to protect, again, some of the pressures that we're seeing across the supply chain. Blockchain technology in terms of being able to do the traceability, to be able to source in the right places, so maybe we can shift to suppliers as we need to in order to reduce our costs, to be able to deal with some of the problems. Blockchain is definitely something that helps in the inflationary environment that we're in.

Matt Orton:
Certainly. Well great. And I think one of the other implications, or challenges that we've seen as a result of this pandemic besides on the inflation front is the need for more and more computing power, the need for more chips and the shortages that we have. And so, one of the impacts I'm sure from blockchain and blockchain enabled crypto specifically has been the rush for more hardware in computing power. We've gone from central processing units in the early days, to GPUs, or graphics processing units, now, to application-specific integrated circuits. So it's becoming more and more complex. And semiconductors, I would assume, have been beneficiaries of these changes. Given that this is your world, how do you assess the investment opportunities right now, particularly as blockchain expands from being mostly utilized within cryptocurrencies to maybe the more broad economy?

Tariq Siddiqi:
Yeah. So semi companies have been one of the earliest beneficiaries of the blockchain technology, as you stated, by the cryptocurrencies. So just to back up a little bit, cryptocurrencies like Bitcoin, are actually created by a process called mining. Mining is performed using sophisticated hardware that solves an extremely complex computational math problem. The first computer to find this solution to that problem receives the next block of Bitcoins. And then the process begins again. So in order to maintain a blockchain and mine these cryptocurrencies, you need a ton of computational power. As a side note, this is why many people complain about cryptocurrency has been harmful to the environment, given how much power it uses. Anyway, this computational need has been a big source of demand for semiconductor chips since 2017, 2018. As you said, early on, people were using expensive, flexible chips that are called FPGAs, flexible programmable gate arrays, the GPUs we mentioned, and so forth, to do this mining work.

As competition has increased, the reward for mining has dropped. And so the miners have shifted to lower-priced chips. Dedicated chips called ASICs built for blockchain and crypto have been introduced. This is especially happening in China where some very large miners have spent hundreds of millions of dollars to build their own dedicated chips for crypto. All of this has led to a step-change in demand for chips, chip-making equipment, and the entire ecosystem has benefited. I don't think currently there's one specific way to play blockchain technology and its impact on the semi ecosystem. But the way we're looking at it is the fact that it has pushed the demands out of the equation for the semiconductor industry, much, much higher than it was before blockchain and crypto came to be. We have seen the supply side remain more or less underinvested for many, many years, but all of a sudden we've seen this pretty, pretty strong impact on the demand side of things.

So not only are you seeing just the chips, they need more chips, but how to design those chips, how to use software that designs those chips in something called the EDA software? How do we produce those chips? Where do we produce those chips? And then the equipment that comes for being the production and so forth. So this exacerbation and supply and demand imbalance that we have seen in the semiconductor world come out of the second half of 2020, post-COVID shutdowns, and then the recovery, has only been exacerbated by the whole entire concert of crypto and then increasingly of blockchain technology.

Matt Orton:
Yeah. No, that makes a ton of sense. And I think it fits with some of the moves you've seen in semiconductor companies over the past year or two. And what I find interesting from what I've read is that many semiconductor companies have actually been integrating blockchain technology into their own operations. And I'm curious to know how they've been leveraging blockchain and also what other industries either within or outside of technology have started to integrate blockchain technology into their operations.

Tariq Siddiqi:
Yeah. So for the semiconductor world, the way they're using blockchain is both in the supply side of things: How to source those chips, where do I go for those chips? If I am somebody who actually just designs the chip and my manufacturing happens in, say, Taiwan or Korea, or what have you, just to make sure that, "Hey, listen, can I get that chip? Where's my chip? Where's my batch of stuff?" And the blockchain can help in figuring out the supply chain side of things. Secondly, they have been using the cryptography and the blockchain stuff within the chip production itself to get more security. So to be able to thwart those security issues that come on the chip level, blockchain technology can help you make much more secure chips. So those, they're called root-level hacks that happen, that happen all the way down to the actual chip while blockchain technology can be in that chip, built in, it can prevent from all that.

So now that's within the semiconductor industry. Now, I'll talk a little bit about the cool examples that we have seen in blockchain and many other industries. The financial world is a very, very cool one, I think. Basically, going from a centralized finance to this concept called DeFi, D-E-F-I, which is a cool short way of saying decentralized finance. Another way to say is like peer-to-peer financial transactions. There are impacts on banking, contracts, mortgages, escrow, real-time calculations, funds traceability, lending and borrowing, insurance issues. And that's even before we consider that digital currency and crypto as a whole and how that will impact the financial world. So going beyond the financial world, however, there are a couple of other areas that I would like to talk about. Healthcare. As we know, the healthcare world has been shifting to digital and electronic records over the last many years, managing all those records, maintaining their integrity, privacy issues, especially when we go into genetic data, is very important.

As an example, the country of Estonia actually manages its entire populations’ health records of about a million people in a keyless blockchain. You can think about using genetic data to develop new drugs without the patient-identifying data being in there. (That) has massive implications as to how future drugs will be developed. Counterfeit issues and pharmaceuticals can be tackled as individual bottles and actually even pills can be tracked down. Blockchain technology can happen all these areas for healthcare. Secondly, in government, here you have things like voting applications and personal identification issues. You can't make up false or fake votes in blockchain world. Data cannot be manipulated. Digital IDs, like licenses and even passports, can be in this blockchain ledger. And of course the issues about speed and international travel issues can all be mitigated if blockchain technologies are implemented properly. Thirdly, in supply chain and you talked about tracking in digital parts or where the food is coming from is paramount.

Blockchain is well in its use already, especially when you consider some of the ESG push that many European companies are under, and increasing will be in the U.S. Related, blockchain can help an asset tracking inventory management that we're talking about. Another very interesting area is media entertainment. Here, blockchain can verify, prevent something like a fake ticket for sporting events and concerts. Promoters can utilize digital tickets and then if that ticket is resold or even scalped, they can make money on that, too. And recall the concept of tokenization that I was talking about earlier. That ticket can transfer about a hundred times and whoever is the one that created the original ticket for that show or that football game can make money each time.

You also have issues on rights and royalties management. Major game consoles and video game publishers are starting to implement ways content creators can track, manage and get paid for their royalty contracts, well after that initial game purchase or that download, et cetera. And then as we're talking about, lastly in cybersecurity, given the decentralized nature of blockchain storage, there's no central entity to attack and no one database would attack to gain access to. Depending upon how well a blockchain system has been set up, no amount of raw computing power can crack the keys to a decentralized database. So there's a huge implication from cyber security companies that really can benefit from this blockchain adoption.

Matt Orton:
So yeah, this is really interesting. And I would say just from this conversation so far, the uses of blockchain are much more pervasive than I even initially thought. So, I guess the next question is what does it take for us to start seeing even more widespread adoption than what we have? I think a lot of us are familiar with software as a service. I've recently started to hear about blockchain as a service. Do you think this could help increase blockchain business applications? And then I guess to bring it back to your world, are there any investible opportunities that come along with it?

Tariq Siddiqi:
Yeah, absolutely. I think the whole concept of a blockchain as a service is very interesting. I think anytime we take the complexity out of something and businesses can utilize the technology without getting into the nitty gritty of it all, it is positive for adoption. So it's still early stages for blockchain as a service. But you can see how someone who can see the benefit of blockchain technology but doesn't have the expertise to build infrastructure, the complex algorithms, the hardware, the chips that we talked about can easily pay someone else to manage all of that and then build the application on top of that.

As you said, the software, the service parallel is very apt. There are clearly massive benefits to going to a SaaS model versus on-premise installed software. And as availability of SaaS has increased, use has just increased dramatically. I think this is something that clearly can happen in blockchain technology as well. However, there is a lot more that needs to be developed and figured out before we get there. Big data center, hyperscale companies have started investing in this area and it remains a very promising way for blockchain technology to get wider adoption. I think it's going to benefit a whole lot of chip companies. A whole lot of networking companies, a whole lot of data center-type companies are very much beneficiaries if this blockchain as a service helps the utility, helps the usage increase dramatically of blockchain technology across various industries.

Matt Orton:
Great. And so Tariq, it's clear that there are some very good opportunities around the potential investment landscape in the near term, as well as you get it more widespread adoption of blockchain technology. I think I know your answer to this, but I'm still going to ask it anyway. Would you consider this to be a long term secular growth opportunity, or is this another trend worth following but ancillary to other growth drivers when we're looking at potential investments?

Tariq Siddiqi:
Yeah, I think as of right now, it's as with anything that's gathered so much attention in the last few years, there's definitely some excesses and lots that needs to be figured out. Let's go back to the early days of internet in the late 1990s. We knew that was something very special, but all the kinks with the business models – how do we deliver this stuff to the actual users? – were still being worked out. They were excesses then and there were disappointments, and there were excesses after that and there were disappointments until we finally got to a place where it could have broader adoption. I feel like that's where we are in the blockchain technology adoption cycle.

There's still very much a secular transition in many cases, but there's still a lot that needs to be figured out and individual quote-unquote killer applications that will bring various aha moments of blockchain technologies. And various industries will come one by one. Until then, there are a lot of very important impacts as we'll bring in the financial world, as we talked about that to start off it, but also in the software space, as we discussed earlier, in the semiconductor space, in the networking. It's really a secular transition, but it's going to take some time for it to actually really filter through and impact a whole lot of different areas within technology space specifically.

Matt Orton:
Well, that is great. Tariq, this has been an absolutely fascinating discussion. I wish we could continue this for much, much longer, but that's all the time we've got today. But I so appreciate you coming back and going into detail on this and that you're welcome back anytime. So thank you to our listeners as well for tuning in and until next time, take care.

Thanks for listening to Markets in Focus, from Carillon Tower Advisers. Please find additional episodes and market insights at marketsinfocuspodcast.com. You can also subscribe to our podcast on Apple Podcasts, Spotify, or your favorite podcast app. Until next time, I'm Matt Orton.


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