Blockchain comes into view

Publication August 9, 2018

Bloomberg reported recently that “if utilities think solar panels and batteries are bad for business, blockchain should scare the bejeezus out of them.”

Four blockchain pioneers talked at the 29th annual global energy and finance conference in June about what blockchain means for the power sector. The panelists are Thomas Folker, CEO of Leap, Michael Horwitz, a partner with Greentech Capital Advisors, Ernst Sack, a partner with Blue Bear Capital, and Kit Harrison, senior manager, North America, for the Green Power Exchange. The moderator is Noah Pollak with Norton Rose Fulbright in Washington.

MR. POLLAK: What are the main advantages of blockchain over what we do now? The technology is also called a distributed ledger.

MR. HARRISON: The approach today of using central servers leaves us one main point of failure, and the servers are expensive to run. A distributed ledger that acts as a record of transactions allows certain efficiencies. It allows peer-to-peer communication and eliminates the need for third parties and big data centers.

MR. FOLKER: The overhead of running a blockchain network versus a centralized one is minimal, and there are some other benefits to it as well. Security is one benefit. You can transact securely between peers without the need for an intermediary to verify transactions.

I like to compare it to the land register. If I want to buy a piece of land from you, I will go to a central register first to check whether you actually own the land. Then we register that transaction, and then everyone else can verify that I am now the new owner.

That process takes time. It is not very efficient, and if you replicate it to millions of devices, it becomes complicated.

With blockchain, you have a technology that has baked in the immutability and verification of that record in the ledger. No third party is needed to verify transactions. I can sell a house peer-to-peer or I can buy coffee from you if you have a coffee place, but the transaction overhead is minimal, and you can transact with millions of peers at fractions of cents. Anyone who worked at a utility knows how much it costs to change just one line item on a bill and knows that there are significant efficiencies to be gained by moving to a technology that handles everything.

MR. SACK: Before we dive into the topic, it is important to defuse some of the skepticism around blockchain as a concept, given how much hype it has gotten. It is also important to separate the discussion into at least two categories. There is cryptocurrency, and then there are discrete applications.

Regarding cryptocurrency, more than 1,600 different cryptocurrencies are now traded on exchanges.

Some people believe they will change the world, where we are tokenizing every asset in the universe. Others like Warren Buffet and Charlie Munger have famously said cryptocurrencies are like finding out your neighbors are trading turds, and you don’t want to be left out of the action. [Laughter.]

What the other panelists are describing are more the discrete applications around supply chain optimization, field services, crypto or cyber security, and there we have real use cases that operators are embracing.

Current uses

MR. POLLAK: Michael Horwitz, what are some of the applications for utilities or individuals that will change the energy markets?

MR. HORWITZ: A couple big ones involve electric vehicles. We have seen big European utilities and even some progressive US utilities look at using blockchain as a measurement and verification tool, as electric vehicle charging stations become more prevalent and multiple users on a daily basis are plugging into them. How do you meter and verify transactions on those systems, especially when you are talking about millions of US vehicles within the next decade? The autos are mini power plants driving around the roads and plugging into grids in any number of utility service territories.

The other big application — we are working with some Australian utilities on this — is how to use blockchain in deregulated markets in connection with wholesale trading of electricity.

Those two are very large potential applications today. The use of blockchain in wholesale trading is probably a bit more challenging given that the technology lacks the speed to transact on a second-by-second basis on that scale. Electric vehicle applications are high on my list of the most relevant.

MR. POLLAK: Ernst Sack, anything to add?

MR. SACK: There are several categories, but we might group them into field services, logistics and supply chain optimization, energy trading and cyber security.

The internet gave everyone access to lots of information.

What distributed ledger technologies and smart contracts deployed on distributed ledgers enable is sharing of assets and data.

Every asset — whether it is a turbine or a generator or a unit of power — can now have a unique identifier assigned to it. The network that is transmitting information about that asset can tell you in a cryptographically secure way who owns the asset, when did the owner take ownership, what price did the owner pay, what rights does the owner have to transmission, distribution and resale of the asset, and how can you engage with the owner to buy or use the asset?

That will allow, for example, tracking and certification of renewable generation or the provenance of parts you are buying to operate and maintain your facilities or tracking your employees. Have they passed the correct health and safety training? Are they certified to work in your jurisdiction and your business line?

MR. POLLAK: Kit Harrison, do you want to talk for a minute about the more specific applications on which the Green Power Exchange has been focusing?

MR. HARRISON: We have been trying to develop a peer-to-peer trading platform for renewable power. The goal is to allow people to buy renewable power directly from the producers and have it delivered to them. We are also developing a form of power purchase agreement to govern the transactions, and we are also trying to allow people to trade electricity like a commodity over the platform to benefit from arbitrage opportunities.

MR. POLLAK: Thomas Folker, Leap is also trying to build a platform on blockchain. To do what?

MR. FOLKER: We are a wholesale marketplace for distributed energy resources like electric vehicles, air conditioners, irrigation systems and anything else that is load controllable. Right now, we are engaged in demand response, which is the coordinated reduction of electricity demand. Once the Federal Energy Regulatory Commission or the grid operators allow it, we will also be acting as a generator or electricity supplier to the grid.

Peer-to-peer is a great concept that we think is a perfect application for blockchain.

We have to be mindful currently that we are still reaching customers through a physical grid. I am not going to install a cable between my neighbor and me to have our own personal grid. If you want to participate in a wholesale market today, you still have to work with the utilities and the grid operators. That’s why we are part of a consortium, called Energy Web Foundation, in which many of our energy partners, like Shell and PG&E, are also active, that provides a standard to transact on blockchain without having to go into a fully peer-to-peer market that might not be regulated.

MR. HORWITZ: Something interesting that Thomas just touched on is the demand response market. PJM had a recent capacity auction that was a tipping point for how capacity markets will value demand response and energy efficiency in the future.

You measure and verify how much efficiency or demand response impact you had after the period. If you can use blockchain to measure the effects in real time, then you can dispense with mechanisms that both restrict these markets from developing fully and allow some utilities to game the system.

If you have a distributed way to measure and verify energy efficiency and demand response, then efficiency and demand response become more valuable alternatives to new generation.

In the most recent capacity auction, you had only about 300 megawatts of new generation clear, which is really incredible. The vast majority was efficiency and demand response, which says a lot about how these markets are changing. Blockchain can help identify the electrons and savings.

Effect on utilities

MR. POLLAK: Should utilities see blockchain as another element of the utility death spiral? Or is it a net positive for them?

MR. HORWITZ: I don’t buy into the utility death spiral. I think that was overplayed about six or seven years ago by an independent power producer CEO, who is no longer CEO of that company. But the utilities are different than 15 years ago when I was trying to help distributed solar companies break through into the US market and utilities were erecting obstacles.

Today, many big utilities are embracing distributed solar. The Energy Web Foundation is a perfect example of global utilities getting together to identify ways to harness distributed technologies. Most utilities have blockchain teams.

MR. FOLKER: The mechanics of the death spiral are largely driven by distributed generation. Blockchain or distributed ledgers accelerate the adoption of distributed generation because they lower the barriers to entry for participating in the trading and distribution of electrons.

If you can see a universal register of all energy that is being generated, stored, transmitted, where, when, how, at what price, at what clearing level, then it is easier to participate in that system, especially if the system is not centrally controlled by an oligopoly of utilities.

That said, a lot of these distributed generation resources will be owned by or be tied to strategic partnerships with incumbent utilities. There is no death spiral if there is collaboration, participation and ownership across that system.

Smart contracts

MR. POLLAK: The implementation of blockchain requires something called a smart contract. Kit Harrison, can you explain what a smart contract is and how it differs from what the audience would think of as a contract?

MR. HARRISON: Contracts are if-this-then-that statements. With smart contracts, everything is codified so it is brought down into its truest if-this-then-that statement.

Smart contracts are difficult to read unless you speak code, so the main issue is getting an interaction between what the smart contract actually says and how people will be able to read and interpret it. The initial step is to load it on the blockchain.

MR. POLLAK: So a smart contract is a contract reduced to computer code. It transacts the transactions in real time.

MR. HORWITZ: Exactly.

MR. FOLKER: It is just a piece of JavaScript code, so I advise everyone interested in smart contracts to learn JavaScript.

It is helpful to understand how these contracts work. They are pieces of code that reside on ethereum, for instance, as a blockchain virtual machine. They are completely open. Everyone can see what the code does.

Once a smart contract is launched and active, no one can touch it anymore, and it is self-executing. It is a series of if-this-then-that statements. There might be a time delay. For instance, an electric vehicle that participates in our market might be called upon for demand response. We enter into a smart contract for the exact price and delivery time. We verify delivery by reading out the meter data, and if the asset actually reduced our load as agreed, then the contract itself executes and pays the electric vehicle owner.

MR. SACK: The governance of that smart contract ecosystem is critical to understand. It differs from one blockchain to the next. Just because we say smart contract does not mean there is no dispute resolution mechanism and no need for lawyers to interpret and enforce that encoded contract.

For example, the bitcoin blockchain is being governed by whoever controls 51% of the mining power, which is largely concentrated in a bunch of specifically hardware-engineered rigs in China. The Energy Web Foundation, or something like any of the 122 energy blockchain startups that are now in operation, may have six or seven strategic investors like a Siemens or a Centrica, or a number of the people in this room on their boards, who vote on which contracts are enforced and in whose favor.

There is high diversity in this ecosystem. You should understand how decisions are made before you commit your capital or your assets into a particular blockchain.

MR. POLLAK: Talk about timing. My understanding is that on the ethereum network, only seven transactions per second can be done. That’s about 18 million transactions per month worldwide. It sounds to me like we are envisioning many, many more transactions than seven transactions per second. We could probably do that volume with the people in this room. What is the plan for being able to scale up blockchain technology in order to handle the volume that everyone hopes to see?

Crypto-kitties

MR. HARRISON: The ethereum blockchain is public. Everyone has access to it.

The ability to scale comes from hosting a private blockchain yourself and being able to meet the computational demands in-house. It is still a distributed system, but it is not publicly all over the world, so you do not have the same number of transactions occurring and the same amount of randomness.

A couple months ago, the biggest news in the ethereum network was this thing called crypto-kitties, which were basically just pictures of cats that people were trading for a lot of money. At one point, something like 10% of all the transactions and computational time on the ethereum network was occupied in pictures of cats. [Laughter] With a private blockchain, that becomes less of an issue.

MR. FOLKER: That is exactly right. There is something called a payment channel on the public blockchain that essentially only settles the transaction at the end of a set time period. It is like a bar tab. You can order as much as you want, but you have to pay at the end of the night and, therefore, you can have transactions — thousands of them — as long as you settle at the end of the time period.

Private or commissioned blockchains by utilities and other energy players have big potential because they are not beholden to the computer power of the public internet, but can be run by the utilities themselves. You can have much greater transaction speed.

MR. POLLAK: The processing power required just to power the bitcoin blockchain today is equal to all the energy consumption in Switzerland. We are still in the early stages of blockchain, and that is only bitcoin.

What is the plan to expand without overwhelming our current electricity supply?

MR. FOLKER: You are right. The bitcoin blockchain uses a large amount of energy because its consensus mechanism is based on mining. Computer power is needed to secure that blockchain. There are other ways to create a consensus mechanism.

The Energy Web Foundation’s consensus mechanism is proof of authority where every transaction is signed off by an affiliate: PG&E, Shell, Centrica. That does not require mining. The electricity usage by that blockchain is minimal compared to the bitcoin blockchain. There are different types of consensus mechanisms.

MR. POLLAK: So you don’t see an exponential growth of energy consumption as blockchain is more widely adopted?

MR. SACK: Maybe step number one, if you are an energy blockchain developer, is do not use bitcoin. It is extremely computationally-intensive and does not have the capacity to manage smart contracts. That is why the ethereum development was so valuable. There are more and more protocols being developed every week.

Bitcoin is a form of currency to buy and sell goods in the market. The energy intensity is likely to be reduced over time as technology evolves. Whether it is proof of work, proof of stake, proof of authority, different conventions are adopted because clearly the trajectory we are on right now is not sustainable.

Security

MR. POLLAK: Michael Horwitz, what do you see as the key privacy and security issues when using distributed ledger technology?

MR. HORWITZ: Most large corporations that are already in transaction systems today, like banks, that may adopt blockchain for various applications are already familiar with how to deal with data and cyber security.

Various breaches have made the newspapers in the last couple of years, but I am more enthused about the distribution of information using blockchain than I am with the information sitting in a data center in the middle of Kentucky for Target, for instance.

You satisfy a lot of security questions just by implementing the technology, especially ethereum and its protocol. It puts users in a more secure position than the traditional ways we have tried to protect data on the internet.

MR. POLLAK: How can that be if everything is being transacted without oversight through smart contracts? Kit Harrison, what type of risks does use of blockchain impose on the utility grid?

MR. HARRISON: I would not say that these contracts are being conducted without oversight.

Information moving from point A to point B is still subject to being intercepted regardless of whether it moves on a blockchain or by other means.

One of the great aspects about blockchain — at least the public ones — is that they are accessible to the public. You can get all the information off them as it is right now. The distributed ledger helps deal mainly with transaction security. You have a digital currency you can use. The real benefit is to be able to transact digitally in a very secure manner.

MR. SACK: I think it is important to differentiate between data security and data privacy.

You will be able to hack into, if it is a private blockchain, or access openly, if it is a public blockchain, all of the transaction data files, but you will not have any idea what the hell they say. They are all encoded, highly encrypted and basically scrambled so that the resource it would take to decode that information is better used on just mining bitcoin legitimately. You will make more money. [Laughter]

MR. POLLAK: Is the real benefit of this technology that standardized transactions can be done millions and millions of times a day or is there some place where more bespoke transactions are appropriately done on this platform?

MR. FOLKER: If you want to have a grid that is more than 20% or 30% renewable — fully decentralized with five million electric vehicles, for instance, in California — then you need to have some way to coordinate that. Marketplaces do a good job at it, but you still need to be able to transact at intervals that are small and at a fraction of cents in cost.

If you standardize the contracts, then you have a platform that can be run cheaply. You can add the bespoke private blockchains — they have their function — but if you want to have a world where all these resources are trading, that needs to be standardized.

MR. POLLAK: Going back to Michael Horwitz again, are utilities already implementing blockchain and, if so, for what purposes?

MR. HORWITZ: TEPCO, a very large Japanese utility, has lost three million customers due to deregulation. It created a new entity that allows customers to be able to have access to energy from various resources. The energy need not come from TEPCO. This is a use of blockchain to keep some link to customers that are no longer interested in being traditional utility ratepayers.

Breaking things

MR. SACK: We come at this more from the operating side, but we are fundamentally venture capital investors. My partner managed the world’s most remote power generation and storage asset on the international space station, so if you want to talk about grid security and transmission challenges, that is a tricky one.

We meet with individuals like those in the room and say, “Here is a blockchain concept, a smart contract, a distributed ledger opportunity. Here is the value proposition the company is putting forward. How would this solve an immediate use case for you? How would this have commercial value for you?”

We have met with several dozen energy blockchain startups over the last 18 months. Kit Harrison and Thomas Folker are leaders in their fields. It is important to acknowledge that it is very early, so if you are looking for an immediate multimillion dollar savings from adopting blockchain today, you will be disappointed. But if you do not spend time working today on proof of concepts and pilots and use cases when many of your competitors are, then that may prove a long-term disadvantage.

MR. POLLAK: We have seen a number of companies use initial coin offerings to raise funding. How do these new funding methods affect the cost of capital?

MR. SACK: There is a token economy emerging now, and it is changing almost week to week. Just yesterday, the chairman of the Securities and Exchange Committee said pretty assertively that he has not seen a single ICO that he would not classify as a security.

The most important issue for utilities that are working with blockchain companies is to make sure to be careful around the management of regulatory risk. You do not want your supplier to end up in jail and not be able to take your phone calls when the network goes down.

Make sure, if the blockchain company is issuing a token that is a security, that it files a Form D and is only raising capital from accredited investors. The cost of capital is probably going to end up converging toward the cost of equity.

If you are working in different jurisdictions, there are places around the world that impose less scrutiny. Then there are companies that are raising $50+ million in ICOs that are basically getting free money from the cartoon cat market. [Laughter]

This is frustrating to legitimate operators because these companies are then using the proceeds in many cases to hire the best developers and, in Silicon Valley terms, to move fast and break things and professionalize after the fact. This is the challenge for the entrepreneurs in the community.

MR. HORWITZ: Watch the way that currencies have been trading. There has been considerable volatility in how the big cryptocurrencies have been trading this year, but the volatility has shrunk dramatically. That is a signal to me that the market is sensing a firmer regulatory environment around crypto, which ultimately will benefit everything about blockchain.

MR. HARRISON: Watching other people moving fast and breaking things is really frustrating because they often lack even a half-baked business plan. They have a pie-in-the-sky vision that does not meet any sort of logical muster. It is frustrating to be in the same sector and have to go through a normal funding.

We are trying to go to a series A right now, and we see others say, “Oh, we’re doing an ICO,” and suddenly they have $20 to $30 million in the bank. Meanwhile, we are going through all the hoops and talking to lawyers, and everything is moving incredibly slowly.

My advice for anyone dealing with this is to go slowly. It is more a matter of luck than business acumen when you are dealing with people who go straight to an ICO. When you hear anyone say, “I invested in so-and-so company and it went up 500%,” that person won the lottery. That is really all that happened.

Audience

MR. POLLAK: Let’s open it to audience questions.

MR. MARTIN: Ernst Sack, you said many utilities already have blockchain study groups. Michael Horowitz, you mentioned this as well. What should the CEO of an independent generator be doing today to prepare for blockchain?

MR. SACK: Spend 30 to 60 minutes on Reddit before you go to sleep every night? There is a lot of value you can get just by paying attention to this community. It does not require budgeting large projects or making investments in start-ups, although we of course encourage that. We love having co-investors from inside the industry. Just be better informed and not as cynical as the headlines may sometimes make you think you should be.

MR. AMSTER-OLSZEWSKI: David Amster-Olszewski, CEO of SunShare. We are a community solar company. We connect directly to the grid, but we sell directly to customers where we control the billing and have a direct relationship with the customers. How would we use blockchain technology in our market?

MR. FOLKER: Community solar is a great example of a limitation blockchain can solve or at least make the business model more efficient. We looked, with the Energy Web Foundation, at something called virtual community solar. Not only is the offtaker virtual net metering, but there is also an aggregation of thousands of solar panels with each being assigned its own serial number or identity on blockchain.

You can literally track production per panel to end-customers, and you can associate your virtual community solar clients with specific production as part of your larger congregation of panels.

MR. DESOUSA: Marco DeSousa, chief legal officer of Fotowatio. For those of us who are less technologically inclined, I was wondering if you could give examples of how blockchain will affect in-house law departments.

MR. SACK: Maybe this won’t answer your question entirely, but I suspect you will agree with it. I think one of the great elements of hubris in the blockchain community is just to say smart contract and assume that means you do not have to know anything about laws and regulations.

One of the biggest effects is recruiters will be calling you after blockchain companies have raised that series A or ICO money wanting to hire sharp contract attorneys to help translate the commercial agreements into code. Coders alone will be insufficient. A lot of these startups are in for a rude awakening.

MR. HARRISON: I fully agree with that. The lawyers are going to have to expand the knowledge base a little when it comes to understanding code, which is kind of a daunting task, but it will be important to bridge the gap between the computational side of the smart contract and what appears in the PDF.

MR. MARTIN: I think we just heard we all need to start speaking JavaScript at home to our spouses so we can get up to speed. [Laughter]

MR. SACK: Just remember that when the robots take over, and they will, you want them to see you as a friend who kinda helped them along. [Laughter]


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