Blockchain: Its Evolutions Within the Energy Sector
According to Deloitte's 2020 Global Blockchain Survey: 39% of companies worldwide have blockchain in production. The truth is that the cryptocurrencies built upon this technology have been volatile. And the technology has already been through a few cycles of maturation. But do not dismiss... Bitcoin currently has a market cap exceeding $117B (with a capital "B"). Ethereum currently has a market cap exceeding $26B. These distributed ledger based platforms can no longer be ignored.
And what about energy? Blockchain in the energy industry is already afoot — and it's important to know how it can solve some of the problems that are out there. While blockchain can be considered a hammer looking for a nail, there are use cases that may be ideal for the technology from upstream oil & gas, commodities trading, to enabling the energy transition.
What Is Blockchain Technology?
I am sure you have read or ignored countless articles, wikis, videos, and more about the underlying technology; however, let me break it down. First of all, I think it is appropriate to go to the Sourcerock and read the initial bitcoin paper written by the mysterious Satoshi Nakamoto. That's right, no one knows if Satoshi is a person, group, or a bot. Regardless, the paper is the genesis of the entire movement and a worthy read.
There are 6 key attributes of blockchain technology that you should know:
1. Decentralized and Distributed Ledger (Database)
A ledger is a record of transactions. We commonly give credit to the Venetians whom invented the double entry bookkeeping method (remember debits and credits from accounting 101?). Unlike Al Capone whom was finally taken down by the U.S. federal government due to them discovering and deciphering his centralized ledger that detailed his vast illegal empire, a blockchain distributes the ledger to all nodes (peers) on the network. There is no central source nor governing authority but rather the entire record of transactions resides on every machine that participates. Each node maintains the complete ledger in tandem with the other nodes.
2. Peer-to-Peer Transmission
A blockchain also communicates using a peer-to-peer network. There are no central servers. As you can see below, I took a screen shot showing a download of the ethereal blockchain. My machine looks for other peers (nodes) and directly connects with them to download the transaction data. Remember Naspter? It took down the entire music industry using peer-to-peer music file sharing (this is not entirely accurate since Naspter did have centralized servers that were eventually shut down; however, its successor e-Mule figured it out).
3. Transparency and Anonymity
Since the entire ledger of transactions reside on every node on the network, this ensures complete transparency (who, what, when, and where). Now at the same time, blockchain technology also focuses on protecting its parties by ensuring anonymity as well as using cryptography to prevent malicious users from highjacking a transaction. Transactions occur between blockchain addresses. A user does not ever have to reveal their real identity and thus there are many use cases that apply to both consumer transactions as well as enterprise. You can read more about the security here; however, let me try to briefly explain. When a node joins a blockchain, the user is given a “private key.” This key should not be shared nor ever given out. A private key (your secret password) is a large alpha numeric code that is used to generate a public key (which is the address…think like a bank account number) in which users share to complete a transaction (get paid, pay someone, etc..). The process of generating public keys and deciphering them is called "hashing." BitCoin uses SHA-256 (Secure Hashing Algorithm 256). While this is not the forum to explain further, it is almost impossible to reverse engineer a public address to find someone’s private key. The process of reversing the process is so complex that the world’s most powerful computer would need more than 40000000000000000000000000000000 years (that’s 31 zeroes!) to complete this calculation. While all transactions are public, the actual names of the parties can stay anonymous.
4. Irreversibility of Records
Transactions are bundled together and added to the ledger in blocks. Once a block is added to the ledger, the next block is chained to the previous block…thus the name “blockchain” (reminds me of “lockbox”, anyone, Bueller?). A great read on how this all works, please read more about “hashing.” Because the ledger is decentralized and distributed on every node and all blocks are chained together in a serial mode based on time, all previous records cannot be modified. This is ideal in environments whereby there is lack of trust amongst parties. What happens when there is a previous transaction that needs to be changed or modified? Either there needs to be a new transaction to reverse the old one or this creates a fork in the blockchain and/or a new chain gets started all together. Want to read about one of the most famous forks in Ethereum's blockchain, check out the return of the DAO funds. Nothing is immutable; however, blockchain technology is best of breed.
5. Consensus Mechanism to Validate Transactions
While there are myriad security mechanisms described above (decentralized and distributed ledger, peer-to-peer transmission, hashing, irreversibility), the consensus mechanism of blockchains is the most discussed and has the largest implications on speed, security, and processing power required. As defined eloquently by investopedia, without a centralized trusted source, publicly shared ledgers need an efficient, fair, real-time, functional, reliable, and secure mechanism to ensure that all the transactions occurring on the network are genuine and all participants agree on a consensus on the status of the ledger. There are numerous methodologies deployed including Proof of Work (“POW”) (currently being used by Bitcoin and Ethereum) and Proof of Stake (“POS”) (Ethereum is moving here and its currently being used by Tezos, Cosmos and a few other cryptocurrencies), and others like asynchronous Byzantine Fault Tolerant (aBFT) (currently being used by Hedera Hashgraph). The purpose of implementing a consensus mechanism is to ensure trust. If you want to learn more about understanding blockchain consensus models, please review the white paper by Dr. Arati Baliga. See below on my explanation on "mining."
6. Smart Contract Enablement
A smart contract is a contract written into lines of code. A smart contract (the agreement) can be coded into a transaction and placed within a block that resides on the ledger. The code can self-execute based upon verifiable events. This capability allows parties that do not trust one another to do business together without the need for centralized governance / enforcement. One of the simplest examples is a vending machine. You put in the correct amount of money into it, the vending machine releases your bounty. A smart contract is the same thing but written as software. As we have seen already in energy, this can dramatically reduce transaction and audit costs.
On a side note, since you have probably heard about "mining", I will discuss this briefly. Proof of Work requires intensive computing power. In simple terms, whichever node does the most work (solving complex math problems), gets rewarded and paid (in the case of Bitcoin mining, the hardest worker gets paid in Bitcoin) to add the next “block” of transactions to the chain. There is an entire industry of Bitcoin mining. Intensive computing power equals large energy consumption. Bitcoin miners currently consume almost ~70 TWh of power annually. This is comparable to the annual power consumption of the country of Austria. For live Bitcoin energy consumption tracking, you can visit this site. This is why many blockchain platforms are implementing different consensus algorithms to reduce the energy demands.
How Is Blockchain Making an Impact on the Energy Sector?
As discussed above, mining requires a lot of electricity. In the beginning miners were using their own computers. Today, miners use sophisticated computers that are designed specifically to solve these complex math problems. These computers maximize computing power while minimizing energy efficiency. The business model is simple: generate revenue by out working others (faster computers) while trying to minimize energy costs. The largest bitcoin mining operations in the world locate around the cheapest energy sources (wind energy in Texas and Morrocco, coal-powered electricity in China, geothermal in Iceland).
However, there's more to it than that. Blockchain brings efficiency. The energy sector is complex and extremely transactional. Blockchain offers the transparency that the energy sector needs reducing transactional costs, audit costs, eliminating manual processes, and reducing the time to get paid. We are already seeing blockchain-based (most people now want to say distributed ledger technology (“DLT”)) platforms find traction inside of the energy industry.
Companies Already Making a Splash
Key companies and energy verticals seeing blockchain implementation:
Upstream Oil & Gas - Data Gumbo just won a pilot with Offshore Operators Committee (OOC) Oil & Gas Blockchain Consortium to implement a pilot focusing on water haulage in the Bakken region. One of the key perceived benefits is the automation of contract payments which should also increase timing of payments and decrease disputes on invoicing.
Commodity Trading - VAKT "is a ‘blockchain initiative’ formed via a consortium of oil companies and banks (BP, Gunvor, ABN-AMRO, Equinor, Koch, ING, Shell, Mercuria and Societe Generale) focused on solutions for post-trade processing. It describes itself as “.. a digital ecosystem for physical post-trade processing. Leveraging blockchain technologies, it is a single source of the truth for the trade lifecycle. It will eliminate reconciliation and paper-based processes, enhance efficiency and create new trade finance opportunities."
Commodity Trade Finance - Komgo is a blockchain-based open platform that is bringing commodity trade finance into the 21st century by optimizing financing processes and accelerating industry operations with digitized transactions and a trusted source of documents to reduce fraud.
Electricity Trading and Retail Electricity - Lo3 Energy is a blockchain based platform to to revolutionize how energy can be generated, stored, bought, sold and used, all at the local level. They partner with utilities, wholesalers, and communities around the globe to enable local energy markets, the most efficient and reliable energy distribution. As the world moves to more local and renewable energy with the rise in distributed energy resources (your rooftop solar panel, home storage like Sonnen's EcoLinx, Tesla electric vehicle plugged into your home, community solar, wind, etc...), there needs to be a transparent methodology for this power to be priced, shared, monetized, and used. LO3 is already working with communities in the U.S., UK, and Europe to enable the distributed grid. (Full disclosure - I am an investor).
Power Infrastructure - Energy Web Foundation is a non-profit focused on building a blockchain platform for other entrepreneurs to build apps on top in an effort to offer increased grid flexibility, along with clean energy and carbon emission traceability. They're putting an open-source platform into place that they tailored to the energy sector. It ensures that they're offering greater value to their customers and that there are market-specific commercial solutions in place.
There's also Power Transition, a company that uses a distributed ledger platform to distribute energy resources. It ensures that all participants within the system have access to data while being able to track, optimize, and balance their energy transactions in real-time at any scale. With Power Transition, their shared language in the blockchain allows all sorts of devices, buildings, and vehicles to be a part of the energy system. It ensures that they can transition away from gas and oil and toward renewable energy.
There are other startups looking to innovate in a way to overcome problems with data management. Blockchain technology has the ability to assist with asset and inventory management. VeChain has partnered with Shanghai Gas, making it possible to track storage, transportation, and other data. Kryha in Amsterdam is working to innovate and enable the plastics circular economy (taking plastic waste and recycling it into new fuels and/or products). There is also a significant amount of transparency and security that comes from using blockchain technology. GridPlus, an Austin based startup in the retail energy space, lets customers cut out the markup charged by outdated and inefficient energy industry practices through giving customers access to wholesale rates. This is made possible using the Ethereum blockchain. Electron, a startup in the UK, is currently exploring new encryption techniques for smart meters as a way to protect private information while taking advantage of communal data.
This is only a subset of the companies and verticals in energy being attacked with new technologies offering a better way... I want to hear from you on which company or area is more ripe for adoption.
Barriers to Blockchain Development in Energy
Although blockchain has its benefits, there are still issues that need to be solved. For example, there is the last mile problem. As MIT professor Christian Catalini states: "the last mile problem is the disconnect between online and offline activities." In other words, in order for a smart contract to execute, there needs to be verification that an event actually took place. In energy trading for example, there needs to be verification that a commodity was actually delivered to the agreed location in the quantity as specified in the contract. Software cannot do this alone today, at least not yet. This is why we are seeing a breed of entrepreneurs innovating to solve the last mile problem. I will write a separate note in what is happening at the intersection of energy and IOT or IIOT Industrial Internet of Things).
In power, there are legal and regulatory hurdles in order to open up local energy markets and peer-to-peer energy trading. Your local retailer, utility, transmission & distribution company, and regulators are still unclear how to best monetize consumers generating their own power, storing it, and then selling excess back into the grid to someone else since it competes against an existing industry in which the business model is to sell you more electricity.
So far, most of the startups and implementations are early, which means that there are a number of questions being asked in terms of how this can be used on a larger scale. Energy is a mission-critical industry. We need scalability, security, and speed. Early results are promising, stay tuned.