Blockchain in the energy sector: Institutional disruption?
Blockchain & Energy: The discussion is heating up
This post is about one of the hottest topics in energy business, the blockchain. While there are many discussions already going on about the technological dimension and business cases based on the new technology, we –as usual – will focus on the institutional side again. Importantly, we intend to sketch a first general picture of the potential institutional implications of the blockchain technology in the energy sector, thereby keeping in mind that the full potential, applicability and success of this new technology is still uncertain.
On 14th February 2017 energy and blockchain experts met in Vienna on the Event Horizon 2017 to discuss the potential of the blockchain technology for the energy sector. The general idea behind such events like the one in Vienna seems to be very compelling: Can we apply a decentralized ledger technology like the blockchain to a system that currently develops towards an increasingly decentralized structure (due to the diffusion of renewable electricity supply and new applications on the demand side, like electric vehicles), like the electricity system? Today, blockchain is a niche topic in energy business, with less than 2% of all startups that focus on blockchain technology targeting specifically the energy sector. However, the incumbent energy business becomes aware that blockchain is an important topic with huge potential.
Now, if we take a look at the debate on the Event Horizon, we see very passionate people from different startups and a lot of enthusiasm. This is because the blockchain is based on a very good selling idea: At low costs, it uses a transparent distributed system that is based on democratic processes and replaces less transparent intermediate services. These three components (cost saving, transparency and democratic decision making) are very compelling and are, at least from our point of view, the main reason why blockchain gains some much audience at the moment. Still, blockchain is in its infancy, with many obstacles to overcome (for a more details see this post). Especially on the technical side, the blockchain technology has yet to prove that it can meet the (very high) expectations. Yli-Huumo et al. (2016) give a nice overview of the current challenges for the blockchain technology:
- Throughput: Bitcoin network is currently maximized to 7tps (transactions per second). VISA (2,000 up to 48,000 tps) and Twitter (5,000tps)
- Latency: To create sufficient security for a Bitcoin transaction block, it takes currently roughly 10 minutes to complete one transaction.
- Size and bandwidth: size of a BitCoin Blockchain is over 50,000MB (February 2016). When the throughput increases to the levels of VISA, Blockchain could grow 214PB each year.
- Security: The current Blockchain has a possibility of a 51% attack. In a 51% attack a single entity would have full control of the majority of the network’s mining hash-rate and would be able to manipulate Blockchain.
- Wasted resources: Mining Bitcoin wastes huge amounts of energy ($15million/day).
- Usability: The Bitcoin API for developing services is difficult to use. There is a need to develop a more developer-friendly API for Blockchain.
- Versioning, hard forks, multiple chains: A small chain that consists of a small number of nodes has a higher possibility of a 51% attack. Another issue emerges when chains are split for administrative or versioning purposes.
From our perspective, especially the energy intensity is very interesting. Croman et al. (2016) calculated for BitCoin that the energy costs related to each transaction add up to 6.2$, given the current design of BitCoin (1 MB per block, latency of 10 minutes). For the future, Croman et al. (2016) project that these costs could be cut by 80% with larger block size (4 MB) and higher latency (12 seconds).
So at this point, we can conclude that the blockchain is a promising technology, but far from being ready for the mass market.
The Blockchain: A brief introduction
In a nutshell, the blockchain is a distributed, digital peer-to-peer register, which stores every transaction between two connected agents in a ledger. This ledger is distributed globally on all connected nodes. This distributed data set consists of a collection of historic data about all transactions made. Each transaction is added to the dataset as a new block (in a linear and chronological order), which results in a full record of all transactions made between two parties. As each connected note carries the same data set, algorithms can be used on each computer to verify transactions. If you want to know more about the technical details you can take a deep dive here.
Currently, many different blockchains pop up. Basically, we can differentiate these chains using two criteria:
- Supervision and control: Is there an institution that controls the blockchain (e.g. decides who joins a blockchain, can delete or alter the data set in the ledger)?
- Visibility: Either a blockchain is public and thereby visible for everyone or private and therefore only visible to the members of the blockchain.
Today, most blockchains are public permissionless ledgers, i.e. there is no central supervision of the ledger and the responsibility to manage the system is with its users. With permissionless blockchains, everyone can connect to the blockchain and use it for transactions.
Figure 1: The difference between private and public blockchains
The public blockchain uses a public and distributed ledger to verify transactions. If there needs to be an adaptation of the public blockchain, this requires in most cases consensus (or at least majority) decisions by all users. On the other hand, one institution or a group of institutions supervises a private and commissioned blockchain. Access to the private blockchain is restricted, verification is based on the private blockchain and the hosting institution is responsible for the management of the blockchain ledger. Figure 2 gives a first overview of prominent examples for permission and permissionless public and private blockchains. Obviously, a permissionless private blockchain is a theoretical construct. So far, this approach has not been used in the real world.
Figure 2: Some examples for permissioned and permissionless / public and private blockchains
The blockchain might change or even disrupt many sectors as it challenges the business case of intermediaries. Merz (2016) here refers to “disintermediation”. So far, many business models are based on the fact that two parties that want to execute a transaction do not have enough information about each other to process the transaction.
In different markets, disintermediation has been an issue for retailers due to new digital platform providers, e.g. amazon, Uber and AirBnB (Merz 2016). Now, the blockchain technology offers the potential to substitute service of intermediates in more than just the retail business.
What’s in it for the energy sector
Expectations are that private as well as public blockchains can significantly alter the electricity sector if the underlying blockchain technology proves successful. In Burger et al. (2016), experts from the incumbent energy business identify the largest potential of the blockchain in retail business. Especially Peer-2-Peer trading offers an interesting potential for the electricity sector.
Figure 3: Potential applications of blockchain in the energy sector according to expert interviews conducted by Burger et al. (2016)
The Brooklyn MicroGrid project by LO3 Inc. as well as Power Ledger activities in Australia nicely illustrate the potential of blockchain for local p2p trade based on the blockchain technology. In these projects decentralized energy providers (households with PV) sell locally produced electricity to their neighbours via blockchain. The combined processing of transactions of physical energy and financial resources seems to be a very promising application for the blockchain technology. However, these projects go beyond retail. They show us the potential of blockchain technology to operate the grid based on a decentralized ledger technology. If we imagine that most devices that are connected to the electricity grid have access to the same blockchain, it seems possible that these devices autonomously coordinate (e.g. via smart contracts) their electricity production or consumption not only according to market signals, but to stabilise the distribution grid. IBM (2015) uses the term “device democracy” to describe the autonomous coordinate between devices via the blockchain.
Given the assumption that the autonomous coordination between the electric devices actually works (meaning that enough transactions per second are possible etc.), we can imagine that the blockchain reduces the complexity related to network operation. For example, the DSO could operate a (private) permissioned blockchain and all devices that are connected to the DSOs electricity grids have to use this blockchain to track transactions. This would give the DSO the power not only to supervise, but to intervene into the processes in the blockchain in case of emergencies. If the stability of the grid is challenged (even if smart contracts are working), the DSO could either use automated processes to secure grid stability (which he can do in any blockchain, private or public), or even stronger measures (resets, stop transactions or “hard fork” i.e. delete all transactions for a certain period).
The institutional implications of the application of blockchain in the energy sector
If the blockchain proves to be applicable in the energy sector, we can expect this to have significant effects. Obviously, the degree to which the blockchain might or might not change the energy sector strongly depends on the specific applications of the blockchain, the regulatory framework and many other aspects. Due to the early stage in the development of blockchain technology, it is not possible (at least for us), to foresee if and how exactly this technology will change the energy business. Some important changes, however, seem foreseeable.
Blockchain can alter the role model in the energy sector
We identify a significant potential of blockchain to change the role concept in the electricity sector. Therefore, we speak of institutional disruption in the title. Some of the existing roles in the electricity supply chain might become obsolete (Do we still need retailers if all data is exchanged directly between the electricity producer and the consumer?), new roles and tasks might evolve and some business cases and roles might not be affected by blockchain applications at all (Does the Blockchain change the electricity generation business case?).
How the blockchain could alter the role of retailers
Most prominently, the blockchain technology has the potential to influence the retail business. The degree to how the blockchain might alter the retail business can vary significantly. First, retailers could make use of the blockchain technology to increase the efficiency of their business by cutting costs. This application of the blockchain would be comparable to the current developments in the finance sector, where the incumbent financial institutions apply the blockchain technology to their established products to reduce costs. While this might offer new business opportunities in the retail sector, from an institutional perspective, the blockchain technology would not change much. Rather, we could expect institutional implications if retail becomes an autonomous application sold together with generation assets (like PV), storages or consumption devices. As a consequence, retail business would be substituted by autonomous smart contracts that are provided together with generation or consumption devices.
How blockchain could alter the role of (distribution) grid operators
Let’s suppose that network operation is based on smart contracts or other autonomous processes that secure frequency and voltage control as well as balancing. These autonomous processes might trigger a discussion about responsibilities: The higher the degree of automation and the higher the number of autonomous devices (generation and consumption) that can provide network services, the lower is the need for supervision. This might lead to the question how many network operators are required and whether the responsibility for network stability could be centralized or even completely decentralized. Such a development would result in a new “market structure” on the network level with either a very high concentration (with just one network operator) or a very fragmented structure with very decentralized network operators (potentially on the consumer level).
This might in turn require an adaptation of the institutional design as well, e.g. the way we regulate the network operators.
How the blockchain could alter regulation of network operators
Concerning regulation, the blockchain might offer the potential to simplify the process of regulation and increase efficiency. Giancarlo (2016) speaks of the opportunity for regulators to get access to the golden record, the real-time ledger(s) of all regulated participants (if the regulated entities make use of the blockchains and the regulator has access to them). Then, the regulator would become able to analyse and understand all processes the regulated entities are involved in.
To apply the idea of the “golden record” to the energy sector could alter regulation, for example of the distribution grid operators, to a significant extent. As described above, the network operators could use (private or public commissioned) blockchains to operate their network. For all those transaction that are executed via the blockchain, the regulator could gain full transparency by connecting to the blockchain.
Furthermore, the blockchain could simplify the interaction between the regulator and the regulated entities. For example, an increased transparency for the regulator via the blockchain about the DSOs activities could change the way network operators can manage their grids. Here, current discussions in Europe focus on the question whether and how the DSO could use flexibility provided by market parties to increase the feed-in of RES. From the regulator’s perspective, the network operator’s interaction with market parties increases the risk of market distortions, at least as long as network operators are not fully unbundled from the competitive businesses in generation and retail (CEER 2015).
Such reservations by the regulator are primarily driven by the missing transparency of company-internal as well as market processes. The blockchain technology might provide the necessary transparency to the regulator, which could drive the regulator to allow the DSO to interact with the market (e.g. based on smart contracts) in the blockchain. Then, the DSO might be able to more efficiently integrate RES, i.e. at lower costs than today. Furthermore, less information asymmetry might reduce the need for further unbundling of DSOs if they want to interact more closely with market parties.
Takeaways
As discussed above, the introduction of blockchains could trigger some institutional changes in the electricity sector. These institutional changes could affect both, the retail and the network sector. We could move towards a world where generators directly sell electricity to the customers, which results in a stronger integration of generation and retail business. Potentially, retail won’t remain an independent part of the supply chain, but an automated and autonomous process conducted by the generators and consumers themselves. Furthermore, the “golden record” idea by Giancarlo (2016a) provides a basis to reduce information asymmetry between the regulator and the network operators, potentially leading to more unbundling than is the status quo.
Are distribution network operators in Europe threatened by a potential application of blockchain technology in the energy sector? This seems to be the pressing question that was at least partially the motivation for a recent report on blockchain in the energy sector by eurelectric, which is the European association of the distribution grid operators. From our perspective, this report reads like an attempt by the industry to reassure itself that its core business model – asset ownership and operation of the electricity networks – is not threatened by blockchain. While this might be true for asset ownership, this is different in the case of network operation.