Impax blog

Blockchain – a look at the wider implications for investment analysis

5 Dec 2017 - by David Winborne

Blockchain is a burgeoning internet-based technology that inserts trust into transaction processing systems by creating immutable records. For Impax, one interesting application of blockchain is its potential to increase the quality of investment analysis through improved company reporting.

The most well-known use of blockchain technology is Bitcoin. This is one of several ‘cryptocurrencies’, which are near-anonymous, secure, decentralised digital assets. However, it is important to know that cryptocurrencies are only one manifestation of blockchain technology. If harnessed and implemented at scale, blockchain has the potential to change how the entire economy functions.

What is blockchain?

Blockchain operates on a ‘shared ledger’ principle. Instead of transaction information being stored in a central location, it is ‘owned’ by all participants in a network, significantly reducing risk. For example, the possibility of information being manipulated or controlled by dishonest means (either through intentional company actions, or from outside interference).

Each input and output is verified and recorded by all parties, rather than a central authority. This system-wide verification process prevents false entries and so the ledger is, in theory, auditable to a perfect degree, at any time, satisfying an increasing desire for transparency from consumers, industry watchdogs, and investors.

Increased transparency for the consumer

The economic implications of a shift towards blockchain use are profound and the technology has the potential to open up new markets and opportunities. For example, with blockchain technology, a potential buyer of clothing will be able to see how socially responsible the supply chain is, from cotton to finished garment. Or in another case, a customer could verify that a diamond has been mined and processed ‘conflict-free’, or confirm that a luxury item isn’t counterfeit. This can be achieved via the use of a physical ‘tag’, which could allow your phone to retrieve information instantly and in an easy-to-read manner.

Possible impact on companies

The ways in which blockchain technology could change existing business models are still being explored. One disruption would be where verification and validation services are performed by third parties. With blockchain, these functions are built into the transaction process itself.

Blockchain could also improve the identification of inefficiencies in manufacturing, as expected output from the amount of inputs into a process can be verified and recorded with perfect fidelity.

A number of the largest technology and banking companies have established and continue to invest heavily in blockchain technology research programmes. One recent example is the ‘utility settlement coin’ (USC). Involving seven global banks, the goal is to create asset-backed digital tokens that can be used to let financial groups execute transactions with each other much more quickly than traditional money transfers allow. Regulatory issues, infrastructure costs, and risk concerns are some of the reasons why many observers do not expect USC to enter real-world use; however, this research does demonstrate how seriously blockchain technology is being taken.

Increased transparency for investors

Impax’s investment analysis includes a broad examination of a company’s inputs, outputs, and corporate actions. We engage on a constant basis, asking questions, visiting facilities, and gathering information. Data availability and its quality is therefore a key part of our analysis. If blockchain use does become widespread, there will likely be an increase in disclosure levels of important metrics, providing investors with a higher level of confidence for investment decisions.

A long-term challenge

The challenges in bringing blockchain technology into mainstream industrial and commercial use are significant. Aside from the sea change in the understanding of traditional processes that blockchain technology requires, there are technical hurdles too. For example, with no current standardisation or oversight (which is billed as one of blockchain’s strengths), there is nobody to turn to in the event of a bug or mistake. All interventions are permanent.

Another issue is energy use. Blockchain processes are currently energy intensive, and although different applications differ in their power demands, and future developments in hardware and software will likely improve efficiency, this does need to be understood. It is probable that the impact of blockchain technology on our everyday lives will occur over many years and gradually.

As specialist, long-term growth investors focused on the transition to a more sustainable global economy, transparency in company reporting is paramount to Impax. Because of its potential to facilitate not just an increase in the quantity, but in the reliability of reporting too, blockchain is a development that may soon become an essential part of investment analysis.