About Christopher Montano

I aspire to one day have enough knowledge to be dangerous.

Blockchain’s “Missing Link”

Following the Links to the Emerald City

When I first heard of Bitcoin, I was fascinated. It was like a tech toybox for me- cryptography, computers, global communication and money. Shiny. What’s not to like? As both a technology and finance geek, the advent of a purely digital currency seemed like the natural next step for money. I had to learn more.

As I researched Bitcoin, I found out that it was enabled by an underlying group of mature technologies collectively called “blockchain.” This platform could potentially be used for an unlimited number of distributed, synchronized applications. Suddenly we could have global, secure transactions at the speed of synchronization without intermediaries. Poof! No more lawyers and the potential for the masses to attain effective tax rates comparable to rich, major international corporations. “How does the story get better?” I asked myself.

But it did get better. I discovered the concept of a “Decentralized Autonomous Organization”(DAO). A new form of a corporation defined entirely by computer code running upon a blockchain. Each DAO’s organization, governance, behaviors and all of its business relationships are determined entirely within computer code shrewdly labeled as a “smart-contract.” Once initiated, a DAO is enabled to function as an ongoing entity requiring no human leadership, no enforcement, no political structures, no intervention or external laws to operate. DAOs hold the promise to eliminate escrow, settlements, and the need for trust others to carry out their contractual obligations or face the hassles and costs of enforcement. Just software acting with computer precision on clear rules that each party agreed upon.

I began to speculate beyond cost savings and regulatory solutions. Could we be witnessing the emergence of a new market form based upon a purely “Digital Political Economy?” Were we seeing the nascent form of an economy that was driven and enforced by contracts running on computers in an open, transparent, self-enforcing manner? One that could not be gamed, rigged, altered or devolve into cronyism? The prospects were stunning. Given the potential economic gains, I knew that sooner or later, there would be a test case to see whether blockchain contained the seeds of a new market structure.

The way of the DAO

Part 1: “To understand the limitation of things, desire them.” – Lao Tzu, the Dao de Jing

In May, 2016, I watched the formation of the “DAO” project closely. The DAO was a decentralized autonomous organization based upon a “smart-contract” running atop Ethereum blockchain technology. Because I don’t read Solidity (the code which the DAO was written in), I had no other choice but to rely upon those that wrote the DAO contract to explain it to me. As I understood, the DAO was to:

  1. Raise a fund of Ether (ETH) over a 28 day “creation period” commencing at April 30, 2016, 09:00 UTC and ending at May 28, 2016, 09:00 UTC.
  2. At the end of the creation period, the pool of ETH was to be used to fund Ethereum blockchain based projects.
  3. DAO funded projects were going to be owned by the DAO with any proceeds from their activities being distributed to DAO token holders on a percentage of ownership basis.
  4. Once initiated, apart from one exception, the DAO was to function solely on the basis of its smart-contract. While DAO members would vote upon projects submitted, there would not be any human intervention needed for it to continue in perpetuity. All interaction with humans, funding, closing, DAO token distribution, project voting & approval, project funding, and ETH distribution to DAO token holders were going to be conducted strictly by the DAO’s smart-contract. Effectively, the distributed computer was in total control.
  5. There was one human interaction permitted. A group of 12 individuals were designated as “curators” whose primary function was to guard the DAO from proposals that could be potential scams. They were to review proposals prior to submitting them to the DAO and designate them as “whitelisted” if they passed several identity and authenticity tests.

The DAO project was a high quality proof of concept for DAOs and especially for “smart-contract” agency. Those who designed and wrote the DAO’s contract were among the core developers of Ethereum blockchain technology and Solidity, a computer language created specifically for Ethereum “smart-contracts”. With a premier technology team, clear presentation and transparent process, all the elements were in place to test the efficacy of smart-contracts and a decentralized autonomous organization under the stress of real world conditions. Like all initial experiments, I knew that there would be surprises, but the DAO’s technologists were best able to eliminate or address potential problems that could derail the test. I was expecting to see if my hopes for a “Digital Political Economy” were merely the last vestiges of adolescent idealism, or the initial step into a bright, new economic era.

Part 2: “Success is as dangerous as failure.” – Lao Tzu, the Dao de Ching

The formation of the DAO exceeded all expectations. Interest was very high and ETH poured in rapidly. The only snag that the DAO encountered occurred one day prior to the end of the creation period. A blog post by several noted experts called for a moratorium on the DAO in order to address potential security problems. Nevertheless, at the end of the creation period on May 28th, there were about 12 million ETH contributed with a USD equivalence of about 150M$. In keeping with the terms of the smart-contract, the assets were fully committed upfront thus eliminating the need for capital calls.

As an investable pool of assets, the DAO sparked a virtual frenzy of activity. Proposals for projects were crafted and floated to the DAO which included a full spectrum from near fantasy to non-fiction. Speculators noted the fund’s success and the ETH price climbed from $8.85 USD/ETH on the day the DAO creation period started to its all-time high of greater than $20 two weeks after the creation period ended. Pundits weighed in from many sides, each talking their book; some declaring that the “end was near” and that the DAO was doomed to fail without human intermediaries and governance. And others, declaring that a new economic era was dawning and blockchain was on the cusp of fulfilling its economic destiny.

However there were others watching too. Others with very different ideas on what to do with the DAO funds valued at nearly $250M.

Part 3: “The further one goes, the less one knows.” – Lao Tzu, the Dao de Jing

One of the features written into the smart-contract of the DAO was the ability for participants to exit the DAO by “splitting” off from the DAO after a waiting period. If an owner of DAO tokens invoked this clause of the DAO contract, then it would trigger a waiting period during which others could join the splinter DAO and exit as a group. At the end of the waiting period, all participants in the splinter DAO would receive their proportional ownership stake at the time of the split. It was expected that splits would be a natural process as contributors’ interests changed.

However, among the first groups to exit, one of the participants understood that the DAO’s “smart-contract” was in fact only a “needs-improvement-contract”. By invoking the DAO’s “split” code in a specific manner, the number of ETH withdrawn from the DAO was not limited to their proportional ownership based upon the amount they originally contributed. This meant that the total number of ETH in the DAO itself could be drained upon exit – even if your initial contribution was 1 ETH.

In the early morning hours of June 17th the waiting period for a split was completed and during the split, an unknown person used this “smart-contract” flaw to begin draining the DAO of the more than 12M ETH collected. Once noticed, a frenetic effort began to understand and stop the exploit. It was soon recognized that the there was no “hacker exploit” involved. The loss did not circumvent the inherent blockchain security architecture, and the “smart-contract” had not been altered or tampered with.

The ironic realization set in that the failure was not security, but in translating the intent of the contract into computer code. The DAO was being drained simply by using its “smart-contract” in an unintended manner.

Since the DAO was written as a completely autonomous, distributed organization, complete agency for the fund was committed to the “smart-contract.” Consequently, there was no provision for human intervention, no “off switch”, no measure to modify the contract should an error be discovered. Furthermore, it was now fully (and publicly) understood that the DAO contract was fatally flawed, unalterable, and unstoppable. The DAO was in peril of losing all of its contributor’s funds within 3 weeks of starting operations.

Table 1: Timeline to “DAOsaster”

Date Event ETH Closing Price (USD) *DAO Market Cap (USD M)
2016-04-30 DAO Creation Period Starts $8.85  
2016-05-27 Call for Moratorium on the DAO (due to security concerns) $11.29  
2016-05-28 DAO Creation Period Ends

12.07M ETH Contributed

$11.56 $140
2016-06-09 Blog post by Peter Vessnes published: “More Ethereum Attacks: Race-to-Empty is the Real Deal” warning about the possibility to drain any DAO contract via balance accounting in smart-contracts. States that notices of potential problems sent to key developers on 2016-06-05. $14.45 $174
2016-06-12 Slock.it Founder Publishes Blog Post Titled,

No DAO funds at risk following the Ethereum smart contract ‘recursive call’ bug discovery

$15.66 $189
2016-06-16 ETH reaches all time high > $20

77% return since DAO Creation Period ended

$20.48 $247
2016-06-17 DAO is drained of millions of ETH by individual exploiting recursive send exploit warned of by Vessnes. There is no way to stop the drain because the smart-contract code is not altered, hacked or otherwise tampered with. No stop switch, no way to prevent the smart-contract code from executing as it is written.

ETH community is urged to join together to conduct a DDOS attack against the draining of the DAO.

$15.35 undetermined



“The DAO Strikes back”

Recognizing there was no way to stop the entire DAO from being drained, an unnamed group conducts a “whitehat” counterattack against the DAO to secure 7.2M ETH into a wallet that cannot be drained.

Market cap decline of 60% from high

$13.39 $96
2016-19-22 Anonymous group claims to file online complaint to Securities Exchange Commission (SEC), European Securities Committee (ESC), and Monetary Authority of Singapore (MAS) regarding DAO hack.

TCR1466578092053 suggests that they used the SEC’s Whistleblower website.

$13.39 $96
2016-06-25 Voting commences on “Soft Fork” of Ethereum blockchain code. Designed to render the ETH appropriated by the “Dark Side of the DAO” as Null and void. However, researchers at Cornell (which called for original moratorium) discover DoS vulnerability in the “soft fork” code. $12.27 $88
2016-07-20 “Hard Fork” in Ethereum code applied, erasing the transaction that appropriated the ETH from other investors. Immutability shown to be an aspirational concept rather than a fact. $12.15 $87
2016-07-21 Refund Period – DAO effectively dissolved and all contributors are able to retrieve their ETH. $12.15 – $11.09 N/A

*There is currently no official tally of ETH at the various dates.

Source: Chris Montaño, CFA, various articles


Fortunately, for an inexplicable reason, the drain on the DAO stopped after more than ¼ of the ETH had been taken. What ensued after the initial loss was more suited to a hacker exploit movie rather than the staid realm of investing (see Table 1.) In addition to the initial failure, the subsequent activity included an anonymous group that conducted a “counter-hack” and drained the DAO of all remaining assets in order to protect the assets from additional losses.

Ultimately, the funds were recovered, but not before the Ethereum blockchain was altered by a controversial “roll back” of the transaction that took the funds. The concept of “immutability” was dispensed but everyone that contributed to the initial fund now has the option to retrieve their funds.

The DAO of the Fiduciary

“It is better to do one’s own duty, however defective it may be, than to follow the duty of another…”        – Lao Tzu, the Dao de Jing

There has been an abundance of analysis on the technological dimensions of the “smart-contract” failure. And there are rigorous efforts to address many of the tech challenges with the code used to create “smart-contracts.” All these are critical for contracts on blockchains to live up to the marketing hype of “smart-contracts” rather than buggy contracts running atop blockchains.

However, I was, and remain troubled there has been no mention of what I consider to be the primary and most basic issue in this entire debacle. The first principal of investing is that agents owe a fiduciary duty toward those whose assets they are entrusted with. In the case of the DAO, a “smart-contract” was given agency over close to $150M of assets and would have lost it all within 20 days but for some equally dubious intervention that would be illegal in a regulated market.

As we look at wildly optimistic market and technology research on the impending era of machine learning, artificial intelligence, and “smart-contracts” running on blockchains, I suggest that now is a time that we assert the primacy of duty and agency. Regardless of whether an agent is a person, an artificial intelligence or a “smart-contract” on a blockchain, once agency is accepted, fiduciary responsibility IS immutable (unlike blockchains).

As we face the prospect of a “brave, new, fintech world”, I know of no current technology that can pass two legal tests of a fiduciary:

  1. Duty in the exclusive interest of clients.
  2. Professional competency – the “prudent expert” standard.

Flashy, shiny, new tech is important to experiment with and test in incubation labs and innovation centers. But until the “fiduciary test” can be passed by a machine, entrusting governance of any sort to machines, will inevitably prove to be a fool’s errand, as in the case of the DAO.

For me, it has been a full-circle lesson regarding the most human and fundamental element of commerce itself- trust. There is an acknowledged trust gap the domain of finance and investments has unfortunately earned. And I do hold out optimism and hope that we will see significant reforms from wise use of technology in finance. However, if we mistake technological prowess for fiduciary duty, we risk replicating the same mistakes in the technology realm that we have made in the financial management domain.


Could Blockchain be Good for our Health?

Part I: If Blockchain is a hammer, my world is made of nails

From the moment I heard of Bitcoin I was fascinated. The concept of a digital currency struck me as the next logical step in humankind’s progress. When I discovered that Bitcoin is enabled by an underlying technology called “blockchain” which has potential applications everywhere- I was all in.

However, shiny, new tech is ultimately measured in providing enduring solutions to big problems.  And product competition shreds away idealism, leaving either the steel thread of a great product or a failed solution.  Electronic Health Records (EHR) stands out as a central, problematic element in modern health care. In spite of regulatory mandates and the medical community’s calls, EHR seems to resist all rational product efforts.

Looking at the world through my blockchain tinted glasses, EHR seemed the perfect test. So I asked myself, “Does blockchain offer a natural, problem-solution fit for medical records? Is there a solid argument for a EHR based upon blockchain?”

Surprisingly, in spite of my unbridled optimism, I discovered some compelling reasons that blockchain merits serious consideration for Electronic Health Records.

Electronic Health Records: Lingua Franca or Tower of Babel?

In an information based healthcare system, EHRs occupy a central role. Borrowing from the disciplines of ecology and biology, EHRs are analogous to what are known as a “keystone species”. The defining attribute of a keystone species is occupying a unique ecosystem niche that “holds it all together.”  Without the keystone species, the entire food web as well as the physical environment collapses.

Similarly, our individual EHRs role in the growing digital ecosystem of modern healthcare are focal points that all stakeholders rely upon. (see Figure 1.) Virtually all medical services utilize EHRs for services delivery, diagnosis, prescription, procedure assignment, billing and payment cycles, population and medical research, and compliance. Without data from EHRs, the system grinds to a halt.

Figure 1 Keystone.png

Figure 1. Electronic Health Records Occupy a Key Role in the Health Services Ecosystem

Source: Chris Montaño

However, there is deep dissatisfaction among physicians and hospital executives regarding EHRs. This has reached a point where the AMA is taking an active role in shaping EHRs by issuing a framework of 8 Usability Challenges that it called upon EHR stakeholders to address. (See Table 1.)

AMA Usability Challenges

Enhance physicians’ ability to provide high-quality patient care. Poor EHR design gets in the way of face-to-face interaction with patients. EHRs should be designed to enable physician-patient engagement.
Support team-based care. EHR systems instead should be designed to maximize each person’s productivity in accordance with state licensure laws and allow physicians to delegate tasks as appropriate.
Promote care coordination. EHR systems need to automatically track referrals, consultations, orders and labs so physicians easily can follow the patient’s progression throughout their care.
Offer product modularity and configurability. Few EHR systems are built to accommodate physicians’ practice patterns and work flows, which vary depending on size, specialty and setting.
Reduce cognitive work load. Many physicians say that the quality of the clinical narrative in paper charts is more succinct and reflective of the pertinent clinical information. EHRs need to support medical decision-making with concise, context-sensitive real-time data.
Promote interoperability and data exchange. The EHR should be a coherent longitudinal patient record that is built from various sources and can be accessed in real time.
Facilitate digital patient engagement. Most EHR systems are not designed to support digital patient engagement.
Expedite user input into product design and post-implementation feedback. The meaningful use program requires physicians to use certified EHR technology, but many of these products have performed poorly in real-world practice settings.

Table 1. Physicians “Must Haves” for EHRs (Edited)

Source: AMA , Chris Montaño

Another looming issue is patient safety. As our medical system has become more complicated, patient safety is a growing problem that cannot be ignored. A recent study published by Johns Hopkins in the BMJ finds that medical error has now become the 3rd leading cause of death (see Figure 2.) When originally conceived, EHRs were seen as a means of preventing errors. Unfortunately, the lack of interoperability of the fragmented EHR market combined with a confusing coding system implemented differently by vendors has devolved into a rising concern. The Center for Disease control recently issued a report calling on Laboratory Professionals to wade into the EHR interoperability issues in order to address patient safety concerns.


Figure 2. Medical Errors are now the 3rd Largest Cause of Death

Source: BMJ

What’s Ailing EHRs?

The vision of an interoperable, HIPPA compliant, elegantly permissioned, highly usable and complete health record remains aspirational. Data are ultimately models of reality. And the truth reflected by data within EHRs is that modern healthcare is complicated and messy at the services, economic and regulatory levels. Health data captured in an EHR is often subjective, not collected or recorded in any uniform manner, and reflecting idiosyncratic workflows of individual caregivers. Health care visits are episodic, non-uniform and baseline information is often recorded during health crises rather than periodically. Thus far, no broad effort to contain the “wildness” of unstructured health data into a standardized model has been successful.

The dynamics within the EHR competitive landscape don’t offer any hope that “EHR kumbaya” with break out anytime in the near future. The market is lucrative, growing, crowded, and hyper-competitive. It is a fierce scramble for market share in an informational franchise on each individual’s complete medical history. If personal information is the new digital currency, EHRs are potentially a “printing press” offering multigenerational wealth to the company that captures this information market. Given these stakes, there is zero economic incentive for vendors to work together on standardization or interoperability.

Lastly, the administrative and bureaucratic dimensions of administering health care among the various stakeholders is complex and in no danger in simplifying anytime soon. Billing codes, local and federal compliance requirements, various industries’ competing interests, medical service specialization, and lack of engagement among stakeholders and the medical IT industry have fostered the current state of confusion.

What about the patients?

Ironically, patients are the stakeholders paying the steepest price and the only ones experiencing existential consequences (see Figure 2.). The frenzy to appropriate EHRs and develop ecosystems with network effects that lock-in patient information behind corporate firewalls have serious implications hardly discussed. Individual patients are paying the price through degraded quality of treatment and having our privacy and dignity associated with our most personal information being trampled upon. Adding economic insult to potential injury or death, we’ve lost control of our digital health records and share none of the profit from intellectual property stemming from our own digital record.  Meanwhile, individuals face opaque medical pricing schemas that are impenetrable and appear to be without any accountability.

Faced with systemic complexity, a massive market opportunity, de facto lock in of an arbitrage model for information generation and ferocious competition, it seemed the perfect test for shiny tech. I thought to myself, “If blockchain EHRs can offer any modest product solution for this multi-headed hydra of problems, there just may be a product in there somewhere.”

Part II: Take a Blockchain and Call me in the Morning

Armed with a serious, large and growing problem set, a very large market opportunity and a host of unmet user and stakeholder needs, I sought to assess blockchain’s capabilities for EHRs versus current solutions. My goal was to answer some basic questions about blockchain technology.  “Is blockchain mature enough to be considered for product development in an intensely competitive market segment? Or is it a nascent technology needing years of development prior to implementation?”

From a product development perspective, blockchain is not a standalone solution for implementing an EHR. Rather, it is an architectural component that enables a total product solution. A large portion of current EHR problems are outside of the scope of blockchain such as user interface design, workflow customization, usability and a large portion of customer experience. In these cases, blockchain needs to enable solutions to important user needs. Customers don’t use (let alone purchase) any product based upon blockchain (or any other technology.) Customers use products that solve their problems and meet their needs. So I asked the question, does blockchain today enable important solutions to customer needs that significantly exceed current solutions?

Blockchain enables solutions to EHR problems today- and tomorrow

Applying blockchain’s current capabilities to EHR needs, I found a natural fit offering advantages stemming from blockchain’s fundamental properties. (see Table 2. Blockchain Enabled EHR versus Contemporary EHR.) Since it is a distributed, synchronized ledger, blockchain is very difficult to tamper with. This provides strong record integrity but does not satisfy rigorous privacy needs as it’s lacking native encryption.  Because it is distributed, it offers high availability and resilience given that there are a sufficient number of geographically distributed nodes. Blockchain has proven that it’s capable managing many parties accessing it simultaneously and is able to reconcile the various events and transactions in an orderly fashion in a reasonable period of time across the entire network of nodes.

Patients are empowered by having ownership, access and control over their health records for the first time. Blockchain enables individuals to give permissions and access to necessary care givers for updates as well as contribute information for population health studies if they so choose. Since patients have control over their health records via blockchain and they are accessed and updated by various care providers, completeness can be achieved for the first time. Regulatory privacy mandates and individual permissions govern copying and reuse of individual health information.

Caregivers receive the benefits of interoperability as well as completeness of records with a blockchain empowered EHR. As patients see various specialists or care providers, each can update the same record blockchain EHR. These are 2 needs repeatedly cited as impacting patient safety. While physicians consistently complain about lack of usability, I think many of the issues of poor usability have little to do with a blockchain ledger. They are a mix of regulatory complexity, insurer bureaucracy, poor user experience design, medical specialization, cargiver workflows variances and complicated procedures and the various ways that health information is collected and reported.



Current EHRs

Blockchain EHR

Patients Access Partially met Met need
Ownership/Control Unmet need Met need
Completeness Unmet need Met need
Privacy Partially met Met need
Availability Met need Met need
Integrated messaging Out of scope Future capability
Automated monitoring Out of scope Future capability
Care-Givers Usability Partially met Out of scope
Workflow Unmet need Future capability
Interoperability Unmet need Met need
Completeness Unmet need Met need
Patient Safety Partially met Future capability
Availability Met need Met need
Billing/Settlement Out of scope Future capability
Regulators Compliance Met need Met need
Privacy Partially met Met need
Security Partially met Met need
Payors Verification of services Partially met Met need
Verification of coverage Unmet need Future capability
Billing/Settlement Out of scope Future capability
Medical Research Access to population health data Partially met Met need

Table 2. Blockchain Enabled EHR versus Current EHR

Source: Chris Montaño

Blockchain’s tamper resistance combined with its complete historical record makes it an ideal system of record. Regulators can use this for auditing and verification of compliance with HIPPA on privacy and access. Privacy needs would have to be met with encryption for individual records during storage and prior to transmission among the various parties. (Details on encryption can be found in the proposed architecture section.) Also, access to patient health information for use in government population health studies are enabled by patients granting use of their information if they choose.

Payors and insurers benefit from being able to audit delivery of services prior to settlement. While fraud from misrepresentation of services delivered is outside of scope, blockchain would make fraud due to record tampering obsolete. Cycle time for data record review and verification would decrease as well as accuracy.

Blockchain EHR Roadmap Offers Compelling Opportunities

While many stakeholder needs are not met today, continued development of blockchain technology offers capabilities that current architectures will be hard pressed to deliver.

  1. Building automated, intelligent transactions into the ledger
  2. Global regulatory syncronization
  3. End of revenue extraction from information exclusivity
  4. End of wholesale medical record theft

The ability to build automated, intelligent transactions into the ledger (a.k.a. “smartcontracts”) offers potential solutions to some of healthcare’s most troubling problems. For example, the opaque, labyrinth of billing and reimbursement cycles. Patients struggle with pre-authorization that payors claim is non-binding. And physicians outsource billing and reimbursement to clearing houses because the pain of getting paid by insurers is so great they are willing to pay others to do it. For example, insurers and payors give pre-authorization for one coded service only to discover later that another code has been entered.

Building intelligent transactions into a blockchain enabled EHR could create an authorization, services, billing, verification and reimbursement cycle where each party’s needs can be met. There could be automated pre-authorization as insurers place policy coverages onto the blockchain. Insurers can receive real time, automated, verification of services matched against insurance coverages and settlement and payments could be handled in a compressed time frame measured in minutes rather than weeks or months.

Hypothetical architecture

There are currently 2 methods for implementing blockchain technology:

  1. “Free Range” Blockchain. This is how blockchain is used for the digital currency, Bitcoin. It is a fully distributed, and an entirely open source code implementation in which anyone can participate. Originally viewed as self-funding and requiring no centralized management, there is currently a foundation that oversees development of Bitcoin. The incentives to establish a full node of the distributed ledger and pay for the costs of running it are derived from the “mining” Bitcoins and additional transaction fees for those that conduct business or send Bitcoins or various alternate coins.
  2. Permissioned blockchain platform implementation in a private network. There are numerous product innovation labs, experimental groups and efforts to commercialize blockchain. The private sector has focused on blockchain solely as an enabling technology and isn’t seeking aspirational elements such as decentralized governance or pseudonymity. From a commercial perspective, ambiguous identity could pose legal and regulatory risk. The solution is to have a blockchain implementation where all participants in the network have strong identities suitable for contractual and regulatory requirements. The cost of creating and maintaining the blockchain distributed network is borne by the organization that creates the permissioned blockchain.

Either “free-range” or permissioned blockchain EHR are possible. However, a “free-range” EHR is better positioned to meet needs of interoperability and individual ownership. Challenges of an open source EHR include resources for development and maintenance of the client solutions. Also, implementation and consulting services would be a grassroots effort until a large base of installations could attract professional services support.

I have developed a hypothetical architecture for a blockchain EHR (See Figure 3. Hypothetical Blockchain-EHR Upload and Figure 4. Hypothetical Blockchain-EHR Update by Caregiver). The components of the system include:

  1. A Client application on the patient’s personal computer
  2. Client application(s) on the stakeholder system (doctors, hospitals, insurance, etc.,…)
  3. A Distributed Storage Network (DSN)
  4. A blockchain to store information necessary to manage individual patient records

The patient client acts as our personal control center for our health records. It allows us to perform a number of important tasks including viewing our health care records, managing permissions for caregivers and other stakeholders to access, view, or update our EHRs. Importantly, it manages the uploading of our health records in a secure manner to a Distributed Storage Network (DSN).

Future capabilities of the patient client might include dazzling features such as managing automated monitoring and updating of EHRs via personal health devices such as sports monitors, implanted insulin administration and dosing, pacemakers and other various devices that are being developed. An integrated messaging and alarming capability could be incorporated to manage communication among the broad array of caregivers and ensure a complete medical record. If the privacy and security needs could be met, there could be an entire ecosystem of healthcare applications that could link to the system focused not only on therapeutics but healthy lifestyles and wellness outcomes.



Figure 3. Hypothetical Blockchain-EHR Upload

Source: Chris Montaño

Since blockchain is not presently suited for large data storage, the expected large amount  of EHR data suggests we need an alternate storage system. There are a number of efforts underway to use blockchain technology within a “distributed storage network.” Included in these efforts are Sia, Maidsafe, Storj, and Ethereum-based efforts. I expect a host of DSN efforts in a rainbow of designs and flavors to percolate forth. The DSN I used in my architecture is based upon the Storj DSN which is currently in beta testing. It is a geographically distributed group of storage nodes available for use to anyone. However, in the case of a permissioned network, the DSN nodes would belong to the company that operates the DSN. The clients in the blockchain-EHR parse a patient EHR into a group of smaller blocks of uniform size. These parsed blocks are then each encrypted and the cyphertext blocks are then individually hashed and sent out onto the DNS. These hashed shards of an individual record are geographically distributed, each are stored at multiple locations such that no location has the information necessary to assemble a complete group of hashed shards of an EHR. The client interacts with the blockchain to record locations of the hashed shards, and is able to audit for tampering using hashes.  The use of blockchain in the DSN means that we can use its multi-signature capability to manage access to the records for various stakeholders.

Security and privacy compliance in the blockchain-EHR far exceeds that of any of today’s EHR systems. The client ensures that no health record information is transmitted in cleartext. And since each parsed block is hashed, auditing for tampering can be integrated into the system with minimal effort. The DSN, contains no clear text of any type and since the blocks are identical in size and hashed files of encrypted information, there is no way to infer content or identity by file size. Since the hashed shards are distributed such that they are replicated across the network with no node containing a complete set of shards of an individual EHR, then even if a node was compromised, the bounty would be a massive set of hashed, encrypted shards of incomplete EHRs- each with their own private key.  Replication ensures disaster proofing as well as high availability of EHRs.

BlockChain-EHR Record Update.png

Figure 4. Hypothetical Blockchain-EHR Update by Caregiver

Source: Chris Montaño

Updates to EHRs are initiated by caregiver client machines making an access request to a EHR owner. If the owner chooses to grant access, multisignature capability in the blockchain verifies and grants access. The caregiver client then receives the necessary information to retrieve the shards which it validates with hashes, then decrypts and reassembles the EHR for viewing and updating. Once the update is completed, the caregiver client uses the same upload process as the patient client and messages the patient that their record has been updated.


Overall, I was more than a little surprised that there was a natural fit and compelling potential roadmap for blockchain enabled EHRs. The one caveat being that the distributed storage networks are early in development and in beta rather than deployed for general availability. If this component proves problematic, then storage of the burgeoning health care data set presents a major design challenge.

The current EHR market confirms the conclusion of natural problem-solution fit. There are several efforts comprised mostly of partnerships between entrepreneurial startups and large IT specialists. And given the potential and extraordinary market size, there are efforts currently underway  with many more to follow.

B-EHR Participants Details
Philips Blockchain Labs Philips Health IT

Gem Health


Multiple announcements with several partners. None which are definitive other than there is a Blockchain Lab
MedRec MIT student effort Latest publication
IBM IBM Launched blockchain services targeted at healthcare and other applications.
Estonian e-Health Foundation Estonian e-Government Infrastructure


EHRs at about $10 per record to participate.

Table 3. Incomplete list of EHR Labs and Efforts using Blockchain

Source: Chris Monaño

Author’s note: There were no Merkle trees altered in the research, writing, and editing of this article.

Annual Reading of the Declaration of Independence: Renewal

As I conducted my annual reading of the Declaration of Independence, I was struck by the thought, “What would Thomas Jefferson write today if he were revising this document?”

Well, I have no idea. So I worked on what I can- how would I revise it? So I did. Before you read it there are a few caveats:

  • I focused on what I know- finance and economics. There is scant technology in the original so this is largely not discussed. The current document gives voice to my concerns regarding the current global economic condition.
  • I sought to edit the original document and insert/excerpt as little language as possible.
  • I avoided the issues related to the current public dialog on security, privacy and surveillance. I deeply believe these are very important, but I wanted an undiluted message communicating a critical issue of our time.

Dedicated to the economic well-being and abundance of people everywhere.


IN CYBERSPACE, July 4, 2014 (238 Years after the Political Declaration of Independence of the United States.)

The unanimous Declaration of the collection of Economically Independent Agents across the planet

When in the Course of human events, it becomes necessary for people everywhere to dissolve the economic bands which have connected them with another, and to assume among the powers of the earth, the separate and equal economic station to which the Laws of Nature and of Nature’s God entitle them, a decent respect to the opinions of humankind requires that they should declare the causes which impel them to the economic separation.

We hold these truths to be self-evident, that all humans are created equal, that they are endowed by their Creator with certain unalienable Economic Rights, that among these are Equal Access to Economic Entrepreneurship, An Unbiased Economic Landscape and the pursuit of Economic Well Being.–That to secure these rights, Governments and Economic Systems are instituted among People, deriving their just powers from the consent of the governed, –That whenever any Form of Government or Economic system becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government or Economic system, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Economic Well Being and Economic Growth.

Prudence, indeed, will dictate that Governments and Economic Systems long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses including concentration of wealth in the hands of a select few, legislation and politics dominated by economic funding and special interests, unchecked power of corporate interests and economic access to those in positions of political or economic privilege, pursuing invariably the same Object evinces a design to reduce them under absolute Economic Despotism, it is their right, it is their duty, to throw off such Government and Economic System, and to provide new Guards for their future security.–Such has been the patient sufferance of these global citizens; and such is now the necessity which constrains them to alter their former Economic Systems including global transactions of trade and state controlled currencies. The history of the present Economic system such as was crafted and evolved since after World War 2 is a history of repeated economic injuries, economic injustice and economic control, all having in direct object the establishment of an absolute Economic Tyranny by a minority controlling Wealth over these people of the world. To prove this, let Facts be submitted to a candid world.

  • The current Government and Economic System has evolved into one of highly centralized control over the majority of the Earth’s Wealth and Resources and Capital flows. This is universally acknowledged to increase economic risk and stifle economic activity and growth.
  • The current Economic System has evolved into one of strict control of capital flows and economic activity through state controlled currencies.
  • The current Economic System has evolved into one whereby Economic Resources are concentrated at unprecedented levels such that economic activity for society at large is at risk. Wealth concentration at current levels is an unsustainable economic system for pursuit of Economic Well Being and is completely unpredictable under stress.
  • The current Economic System has Centralization of Economic Resources thereby creating an unprecedented Economic Risk to the economy of the world.
  • The current Economic System has evolved into one of centralized control of capital among a small cartel of banking and corporate interests thereby subjecting the world to unprecedented economic risk through contagion during times of economic stress.
  • The current Economic System has evolved into one of riskless (arbitrage) profits for those controlling capital. This is a fundamental violation of free market principles. Whereby those controlling capital have profited from a highly advantaged economic position and taken unreasonable risks resulting in their economic ruin being averted solely through extraordinary use of public capital. There have been no legal or economic costs associated with this economic abuse.
  • The current Economic System has evolved into one whereby those controlling capital have been found to perpetrate economic abuse through market manipulation of key economic resources and metrics such as LIBOR, Gold and others. For this, there are no legal or economically relevant consequences.
  • The current Economic System has evolved to grant even more economic privilege to those currently holding it most. Access to Economic opportunity is fundamental and necessary for a vibrant global economy.
  • The current Economic System has evolved into a symbiotic relationship between legislators and their economic donors resulting in the passing of Laws of immediate and pressing importance to donors to economic detriment of broader society. This stifles economic competition and stilts the emergence of innovation in businesses, entrepreneurship and technology.
  • The current Economic System has evolved into one of privilege for the privileged and has neglected to pass other Laws for the accommodation of large districts of people seeking economic growth and well-being. The current donor-patron system of legislation fails to address the economic interests of the greater majority of people in the world. These people of the world often have either never been granted the right of Representation in Legislature or have lost it, a right inestimable to them and formidable to economic tyrants only.
  • The current Economic System has called together bodies of Economic Privilege at places unusual, uncomfortable, and distant from the depository of their public Records, for the sole purpose of forging these bodies of Economic Privilege into informal systems of political and economic influence that maintain their economic dominance.
  • The current Economic System has leveraged the unequal economic access to legal representation repeatedly, for opposing with manly firmness any legal challenges to the Economically Privileged invasions on the rights of the people.
  • The current Government and Economic System has evolved for a long time, to cause others to not be elected that represent the economic interests of the lower economic strata; whereby the Legislative powers, incapable of Annihilation, have returned to the People at large for their exercise; the vast majority of people of the world remaining in the mean time exposed to all the dangers of economic distress from without, and continued economic erosion within.
  • The current Government and Economic System has endeavored to prevent immigration reform, except for the interests of Corporate patrons. Resulting in the obstructing of Laws for Naturalization of Foreigners; refusing to pass others to encourage their migrations hither, and thus limiting access to economic opportunity.
  • The current Government and Economic System has erected a multitude of New “Security” Offices, Policies, Secret Legislation, and aggressively conducts active, deep surveillance, and sent hither swarms of Security Officers to harass and surveil our people, and erode our economic competitiveness.
  • The current Government and Economic System has kept among us, in times of peace, Standing Armies of Governmental, Private and Corporate Intelligence without the Consent of our legislatures.


In every stage of these Oppressions We have as a whole failed to adequately Petition for Redress in the most humble terms: Our failure to Petition Effectively have been answered only by repeated injury. A People that bear up under Economic Tyranny without refusal, become thus marked by every act which may be inflicted by an Economic Tyrant, is unfit to be a free people.

We are this day called to Petition Effectively by economic activism in line with the principles of:

  • Equal Access to Economic Entrepreneurship
  • An Unbiased Economic Landscape
  • Economic Well Being
  • Liberation for Control via State Owned and Controlled Currencies

Nor have we been wanting in attentions to the current Government and Economic System. We have warned them from time to time of attempts by their neglect of legislature that they extend an unsustainable economic risk over us. We have reminded them of the circumstances of our emigration and settlement here. We have appealed to their oaths to the Constitution of the United States, or native justice and magnanimity, and we have conjured them by the ties of our common kindred to disavow these acts of Economic Tyranny. They too have been deaf to the voice of economic justice and of consanguinity.

We, therefore, the Citizens of the Global Economic Community of Humankind, Decentralized, Unassembled, appealing to the Economic and Political Leaders of the world for the rectitude of our intentions, do, in the Name, and by Authority of the good People of this World, solemnly publish and declare, That these Citizens of the Global Economic Community of Humankind are, and of Right ought to be Economically Free and Independent Economic Agents; that we are Absolved from all Allegiance to trade strictly by State Controlled Currencies, and that Economic Repression via Control of Currency and Capital, is and ought to be totally dissolved; and that as Free and Independent Economic Agents, they have full Power to conduct Commerce, conduct Trade of Goods and Services. Make Contracts, establish Commerce, and to do all other Acts of Economic Activity, Growth and Entrepreneurship, and Things which Economically Independent Agents may of right do. And for the support of this Declaration, with a firm reliance on the protection of divine Providence, we mutually pledge to each other our Lives, our Fortunes and our sacred Honor.

Calling for a “Magna Carta for the Internet”- Thanks Tim!

In my last post I was bold and earnest in calling the Internet the center of gravity of human rights in the world. It was for me, a dangerous post. It is not the kind of strong opinion that someone looking for a job in a small technology company is counseled to post in social media. However, I wanted to be honest and candid on my thoughts and who I am. (frankly, I see individual authenticity as perhaps the only true competitive advantage there is for people.)

I was exhaling a sigh of relief this morning when I saw the fabulous article by the Guardian about Tim Berners-Lee (inventor of the world wide web). In it, he calls for a “Magna Carta” for the Internet. I want to highlight it here and state that it does reinforce my initial thoughts from a highly credible and insightful source. The Internet is constantly in flux and I continue to maintain that it is the central focus of human rights. This is gaining momentum and companies and investors and governments can adapt or … well you get the picture. Thanks for the voice Tim!

*note- for some reason, WordPress was not able to insert a link into my post of the article which can be found here: http://www.theguardian.com/technology/2014/mar/12/online-magna-carta-berners-lee-web

The End of the Beginning

“When I was a child, I spoke like a child, thought like a child, reasoned and acted like a child. But when I matured, I actively stopped behaving and being treated like a child. Currently we see an enigma, but eventually there will be complete transparency. At this time, I only see pieces of the whole, but inevitably I will be able to fully understand what is going on, exactly as I have been fully understood.”

(1Co 13:11-12 paraphrased by Chris Montaño)

Stage 1. “Childhood’s End (1973 – 2013)”

In a recent Harvard Business Review post, Bruce Schneier compares the current state of security on the Internet to a feudal system. I have always liked Schneier’s take on security and privacy. He is a thought leader as well as facile “synthesizer” and communicator. He also has been a rare civilian cryptographer/cryptanalyst that has published several books on cryptography and is respected for his technical work. He recently joined the board of Electronic Frontier Foundation.

In equating the Internet to feudalism, Schneier is talking mostly about IT security and privacy. However, whether intentional or not, I think he is making a broader statement in a quiet manner. I think he has identified an IT reality, but also touched a raw nerve of the realities of a globally, internetworked society. We live with the Internet like serfs lived with feudal lords- in a state where we are viewed as “resources” rather than regarded as individuals with intrinsic human rights.

Imperial, unaccountable, idiosyncratic, personality-driven; feudalism is a system where the masses have little to no legal rights, little to no due process, and virtually no formal institution of political or economic power. Society’s resources may be diverted to the ruling elite and vassals roles are to serve up any and all resources required of us by the imperial. Feudalism is very simple – the masses trade our autonomy for civil structure and protection against chaos.

However, I think that the time is ripe for the next era in the use of the Internet. I think that we are either near or at a tipping point where we will demand that our fundamental human rights be recognized, honored and legally regarded on the Internet. While I consider Ed Snowden’s actions as criminal espionage, the resonance of his claims regarding privacy violations was a “weak signal” indicating forthcoming change in how we are treated as individuals on the Internet.

I surmise that this change is inevitable, because feudalism failed to maintain the social contract in an era of growing knowledge and maturing world views. It resulted in major social problems and was consequently dispatched to the dustbin of history as a rudimentary form of government because it simply didn’t work anymore.

Similarly, over the past 40 years we have been led by companies and the government into an international network of information access. The change was so significant, that it necessitated strong controls to help the world understand what the Internet is, how to use it and become part of the information explosion we are amidst. This was a necessary stage so that we could all reap the benefits of the instant knowledge available for the first time in history.

But we are more mature now. And the current system of surveillance business models which spy on us, repackage and productize and sell the results for outrageous profits will increasingly, not work. The detrimental impacts of concentration of income and wealth in the richest 1% of society cannot be overstated. Simply put, our current model of Internet usage and business no longer works for society. And similar to monarch rule, is destined to change significantly in the next 10-20 years.

Figure 1. Income Growth now Exclusively for 95-99.99 Percentile

Income Inequality

Source: NYT: Our Broken Economy, In One Simple Chart

Stage 2. “In the course of human events…” (2013 – ?)

I have a personal tradition that on the 4th of July, I renew my view of our state by reading the Declaration of Independence. It is a short document and a welcome opportunity to refresh my ideals so that I can face the often times cynical news flow throughout the year. This year, as I read the Declaration of Independence, I was gripped with the perspective that the state of the individual on the Internet is in a near identical situation as the 13 colonies were in 1776. We receive no hearing by the “rulers”, laws are made without authentic consideration of users, we are treated like an information resource to be bought or sold, rather than as persons and given little respect for dignity, privacy, personal information property – let alone legal rights. The colonists found themselves under a form of leadership that wasn’t sustainable. And in response, they worked for several years to develop something completely new.

With clarity and simplicity the signatories stated, “We have grown up. We require you to treat us not only as adults but equals on completely new terms. We are not asking permission but notifying you and everyone else what we are doing.”

There are several points in the Declaration that I wish to emphasize that are relevant to the Internet and our what I believe is our changing role as individuals:

1. Autonomy is a natural evolutionary process that results from maturation.

While we assail feudalism, we need to recognize that for a time, it worked. It served a purpose. But “When in the course of human events…” we grow, we evolve, we understand ourselves and our roles in the world in a more mature manner and wish to exert our autonomy and power. I believe that we have reached the point in the evolution of the Internet where we as individuals will begin to reclaim and assert our rights and autonomy as individuals.

I think this is true, not because of any political or philosophical view I hold. It is based upon the current generation that is dominating the Internet globally. This current generation holds a richly textured, sophisticated technological and societal perspective of the Internet. Having been in the middle of the Internet’s explosion into the public consciousness during the late 1990s, I am truly wowed by their intuitive understanding of how the mechanics of the Internet interact societally. An example of this is the role played by Wael Ghonim in Egypt’s revolution. This generation is truly remarkable and deserves to be recognized as the pioneers they have proven to be in their actions. They are leading this transition into this next era. And as Egypt demonstrates, it won’t be easy. But this transition is part of the natural evolution of society. I believe it is unstoppable. However, I don’t for a moment think it is beyond being repressed and it will certainly be opposed by those who will lose economic and political power.

2. Assertion of the unarguable legality of autonomy, equality, dignity and respect for the individual- you either get this or you don’t.

Our fundamental human rights are not a debatable point; it is how we view ourselves. It is THE super-ordinate value and consequent world view we possess. All that we are as a society and government rests upon this fundamental assumption. We have built our nation on the premise that individuals have unquestionable legal rights of dignity, autonomy and reasonable freedom to pursue our personal growth and maturity [life, liberty and the pursuit of happiness].

The next era won’t discuss whether human rights will be extended to the Internet, it will be about the struggle to assert the human rights we intrinsically hold. There will be no dialog about the fact that we are bestowed with “… certain unalienable Rights, among these are Life, Liberty and the pursuit of Happiness. …” (Please note that this is not an exhaustive list, it is a call-out of some important rights among others.)

It is my view that a mature governmental and business perspective must understand this basis of our society in order to have a long-term, viable government or business. Governments that deny this fundamental truth will eventually be rebelled against as the Founders did against their taskmasters. And companies that are not able to grasp and honor this fundamental truth of customers’ rights and dignity will eventually crash, crumble or decay. The best they can do is control the trajectory of the transition and so maintain a legitimate role.

3. It is harder to change than to suffer, but a tipping point is eventually reached.

It is fascinating to read the 18th century equivalent statement that I expect to find in a contemporary self-help book. Apparently, it has always held true that if the data demonstrate a consistent pattern of abuse without recourse or adequate response, there is no other choice but radical change. Companies and governments love our current system. In it, they hold all the cards and all the money, they make all the laws, and they get most of the benefits. I won’t belabor the 99% arguments that others have made so much more eloquently than I could, but I will point out that we are hurtling toward an unsustainable economic and political imbalance. As circumstances continue concentrating economic and political power, societal pressure is building and will eventually drive change. The combination of non-sustainable economic profits and unabated surveillance by governments and companies is driving us toward this tipping point.

It is not only the U.S. government that is grappling with changes foisted by the Internet, Egypt demonstrates that any educated population requires a measure of freedom, order and autonomy. While repression is real and can persist for a long time, ultimately, an open Internet will lead to big changes. Hence, non-progressive governments are scrambling to erect Internet firewalls that edit content that could potentially instill ideas of individual freedom. In absence of active, aggressive repression, the Internet offers an unprecedented channel for knowledge, education and freedom of press. If governmental power is rampantly abused, there will come a tipping point where a rigged legality is trumped by broadly recognized lack of legitimacy. This is a dangerous place to go and I hope we don’t.

What I haven’t seen yet, is the commercial equivalent where individuals begin actively rebelling against their corporate feudal lords. Examples of this could be an anticipated wave of privacy based companies or some form of information co-op whereby individuals band together for network economics and control the flow and payment of personal information assets. There could also be legislation explicitly declaring that content we naturally generate from of our lives is personal intellectual property and therefore covered underneath IP law. That we own it and it may not be stolen or used without our consent. It may be the case where legally, individuals are given special protections to compensate for the resource imbalances between corporations and people. I personally believe that the golden era of personal information arbitrage is over- not because of political or philosophical ideology, but because all economic profits eventually trend to zero. Smart companies, entrepreneurs and investors recognize this and may already be starting companies and adjusting their strategies, expectations and business trajectories.

4. Autonomy is hard and requires commitment, focused attention and our resources.

As serfs maturing into responsible adults, we have a lot to learn and it is going to be hard. It will require our efforts and resources. This is the weight on the other end of the individualism and rights- they are costly and weighty.

Some will rise to the challenge more effectively than others. Some will be able to develop and lead, and others will cling to what they know because it is easy. But I think that history shows that as we mature and grow individually and collectively, our structures and forms of society must either evolve with us or be swept away. Our choices have never been easy. But a reading of that magnificent document that is the Declaration of Independence, reminds me that that growth and maturity is the struggle that builds strength enabling us to move yet further again.

I am not calling for anything other than recognition and legal enforcement of the fundamental human rights we recognized in our Declaration of Independence, United States Constitution and Bill of Rights. I say this because it is who we are and how we defined our society to be when our nation was created. I think that the founding fathers got it right on the human rights ideal. As we have for the past 237 years, we practice our ideals imperfectly, but guided by the ideal of respect for each person and their unquestioned value. I am simply pointing out that I think that this ideal will eventually embody itself in how we are treated on the Internet and that this change is inexorable and inevitable.

Energy 3.0 At the Cusp or on the Brink – Part 3 Will the Last one off the Planet Please Turn out the Lights?

“You have to go out – but you don’t have to come back!”former, unofficial motto of the US Coast Guard

In Parts 1 and 2 of my series, “Energy 3.0 At the Cusp or on the Brink” I began developing my 7 theses of investing in Energy 3.0. The 7 theses are displayed in Figure 1.

Figure 1. 7 Investment Theses for Energy Investing

Source: Christopher Montaño, CFA

In my posts 1 and 2 I covered the first 4 energy theses; Energy = Life, Energy = Commodity, Energy is Political and Energy is a Mature Market. The results have been fairly dismal. In my discussion we have seen that:

  • energy is critical
  • energy is a commodity -regardless of intellectual property
  • the industry requires political involvement
  • it has regulatory encumbrances
  • it has a low margin structure
  • there is low customer engagement -regardless of technology
  • and if these aren’t enough to discourage you there are “supercompetitors” in the form of regulated monopolies that devour everything in sight in excruciatingly slow fashion.

By now readers may well be asking, “Given your investment theses thus far… what’s the use investing in the energy sector?

Cheer up, it gets worse

This brings me to my 5th investment thesis:

5th Investment Thesis: Sustainability Mandates Investment Capital.

My 5th thesis is that in order to sustain our global economic growth, and sustain our population base, we have to allocate capital investment into energy supply and demand. We simply have no other choice.

Simply put, we do not have detailed understanding about our planetary natural resource limits and our population is getting very large. I also believe that there are major global economic and demographic shifts that will accelerate natural resource consumption during this century.

In 2010, we reached a global population of 7,000 million people. The United Nations projects that during the 21st century, the global population could reach as high as 16,000 million people. (See Figure 2.)

Figure 2. World Population Growth Scenarios

Source: United Nations World Population Prospects:  The 2010 Revision

The truth is that we don’t have a firm idea of how many people that the earth can support on a life sustenance basis, let alone on a growth and consumer based lifestyle basis. From where I sit in 2012, 10,000 million and certainly 16,000 million seem impossibly large numbers of people for the planet to support. I concede that at one time, 7,000 million probably seemed impossible, yet we are managing- for the moment.

Where’s my iPad & iPhone?

The big uncertainty comes in the form of global consumption patterns due to economic development. The good news is that the emerging and developing markets are moving along nicely in their economic development. The bad news is that there is a large population base that’s driving toward consumption patterns like us– the developed economies. There will be significant impacts upon natural resources due to shifts in global consumerism.

There are two waves of population bases that are migrating economically this century. First there are the population in the emerging markets and after that there are the “frontier markets”, the next wave of economically developing countries. Both of these markets represent a large population base that will be attaining a consumer based lifestyles of various levels during this century. This is a large increase in absolute numbers of people that will be consuming natural resources, durable goods, non-durable goods, food, etc…  — and this demographic wave will drive energy demand.

The emerging markets powerhouses “BRIC” (Brazil, Russia, India, China) are already a growth engine for global economic output. When their populations gain greater discretionary income they will begin consuming more along the lines of developed countries via automobiles, housing, clothes, appliances and food- and ultimately energy. How this will impact global stocks of natural resources is unknown. How long will the global stocks of petroleum, natural gas and coal last? This is uncertain and the data are not uniform or estimates closely clustered. Beyond this there is an issue of even if we have fossil fuels to support these new consumers, how do we impact the atmosphere?

Historically there has been about 43% of the world population in the BRIC countries since 1950. These four countries currently have 2,900 million people in them and are projected to peak out in population in 2045 at 3,349 million people (See figure 3.) On an absolute basis this is an increase of 445 million people in 35 years. (For reference, the previous 35 year period saw a growth of 1,160 million people amongst the BRIC countries.)

Figure 3. Population Growth Among the Big Four Emerging Markets, Brazil, Russia, India, and China

Source: United Nations World Population Prospects:  The 2010 Revision

One factor not included in the BRIC countries are their consumption patterns. The number of people moving economically upwards is very large. Common sense suggests if consumption patterns match the current developed world, then this will place a strain on all sorts of natural resources and derivative products. We wonder at what level of annual income does the consumption pattern of a population base enter exponential growth?

The situation becomes more complex as we consider the Frontier Markets. These are the large number of countries that have not been economically developed and are just beginning their economic growth – often based upon human capital arbitrage, global transportation and communications networks. The Frontier Markets include the following countries:

Table 1. Frontier Markets

Within this list are 88 countries that are staged to experience rapid economic growth in the middle and latter portion of this century. These countries are the next wave of consumption behind the traditional emerging markets and also have a large population base. Figure 4 details the middle scenario population growth through this century of the frontier markets. There are currently about 1,700 million people in these countries and the UN expects that number to increase by 1,300 million by 2050 and another 1,000 million by 2100.

Figure 4. Population Growth of Frontier Markets in 21st Century

Source: Source: Christopher Montañ0, CFA, United Nations World Population Prospects:  The 2010 Revision

If we combine the “BRIC” emerging markets with the frontier market populations, then in 2050 we will have a net population of 6,300 million consumers at lesser, but rapidly growing consumption levels than the developed nations. The population by 2100 of these same countries is estimated to be almost 7,000 billion people.

The consumption patterns of economically developing populations may vary from country to country. However it’s clear that fundamental human nature is to move toward ease of existence and actualization. The famous “S-Curve” (Bass diffusion curve) is the most basic of all market demand forecasting tools. New products that people like invariable have exponential demand until a natural level of saturation is achieved. There is no reason to expect that this will be different for the 7,000 million new consumers as they think about cars, televisions, clothes, housing, HVAC, etc… Without diving into excruciatingly deeper data, suffice it to say that sustainability and energy demand will be major, growing issues throughout this century.

How do we provide energy for this growing population group? The answer is likely to be any way possible. While the implications take effort to digest, one is clear. Without massive, global capital investment in all phases of the energy value chain, we will not meet demands during this century for continued economic growth and perhaps, even basic sustainability itself.  It is this fundamental driver of sustainability that I view as a primary thesis for investing in the energy value chain.

The first 4 investment theses dealt with the risk factors in investing in Energy 3.0. In this post, I turned toward a fundamental demand driver- population coupled with global demographics and economic growth. And it is this key factor that investors have responded to in the past 5 years.  However, there are now the challenges that are rearing up in the time period prior to the exponential knee of the growth curve. And it is exactly at this time that patient, wise  investors redouble their efforts in learning how operations and companies succeed in markets. It is also the time where less hardy investors may lose interest or be forced out of a market.

Energy 3.0 At the Cusp or on the Brink – Part 2 Introducing Seven Investment Theses for Energy Investing- First the Bad News

In my first post in this series I looked at the grand theme of “Energy = Life”– fun stuff spanning the scope of human history but not actionable. However, I maintain that context is important when considering investment themes. And given the historical impact of energy on the human condition I thought it merited an entire post to establish the proper level of gravitas this sector holds.

In this post I will transition into more pragmatic comments and lay out some basic investment themes for the Energy 3.0. I will break it up into a series of smaller posts for the sake of brevity. I don’t assume that this list of seven is complete. It would be arrogant to assume that I could capture all important Energy 3.0 investment theses in seven statement but I must somehow be practical in my approach. Feel free to chime in with additional themes. Disclosure- I hold that investment theses aren’t static and reflect the changing markets. These are what I see today with my limited perspective and my theses are subject to change based upon new information and market dynamics.

7 is the Lucky Number for Energy Investors

I have developed 7 fundamental theses on investing in the Energy sector.

Figure 1. 7 Investment Theses for Energy Investing

Source: Chris Montaño, CFA

Thesis 1: Energy=Life

The first thesis, Energy=Life was covered completely in Part 1 of this series and I will refer you to my prior post. Suffice it to say that we need water, air and food to live. However, it takes energy — lots of it, to be a civilization so this is a sector that will be of high importance for a long time. They primary point is that we need to upgrade, renew and invent new ways of creating, delivering and using energy for our civilization to continue its trajectory of population growth, economic and technological progress.

Thesis 2: Energy=Commodity

Almost the direct opposite of Energy=Life thesis is that Energy=Commodity. While this is not exactly true, there are several reasons that an investor in the Energy 3.0 sector needs to understand this concept. Since the basic inputs to our energy system are commodities, it’s unsurprising that downstream products (electricity, gasoline, fuel, etc…)  take on many of the same properties.

One of the most important properties of commodities is that any substitute must be cheaper. The basic properties of commodities aren’t variant so it is really about the economics of substitutes. Any replacement of a hydrocarbon with a renewable source must be driven by cheaper economics. One important implication that has not been lost on the investment community is that we are still a long way off from unsubsidized renewable generation being cost equivalent with hydrocarbons. The fact that there is simply so much technology involved in deploying an alternative energy source leads me to be cautious regarding the time frame when a photovoltaic chip or thin film can compete with geologic time scale processes that produced coal, gas and oil. I consider the current vintage of renewable source energy investments to be experimental and its economics driven by anticipated supply shortfalls and geopolitical concerns rather than renewables working their way down the cost curve.

When you couple the economics of commodities with the perfect substitutability of electrons (or many petroleum based products) it is understandable that customer engagement for energy is very low.  From a customer perspective there is little to no differentiation between electrons or fuel sources.

In fairness to the boldness of alternative source energy entrepreneurs, there is a need for the industry to work down the cost curve and contend for financial viability. There are reasons to persist and push the cost effectiveness envelope. We do not have an accurate understanding of the true level of reserves in the oil, gas and coal global raw stocks. If there are shortfalls then the economic crossover point for alternative energy sources may shift dramatically as prices of hydrocarbon sources increase. There also remains the problem of global climate warming. Even if global raw stocks are sufficient, then it may turn out that we can not burn fuel for 7 billion plus people without accelerating an already perilous atmospheric carbon condition.

Thesis 3: Energy = Politics

On a global basis, governments are deeply involved in energy. This is also true at the state and local level. The energy sector is subject to administrative laws and state, and federal regulations. While the petroleum industry is not a regulated industry as is electrical generation , there is still a high level of government involvement — especially as problems occur. For the investor in energy, regulatory engagement is not optional. Depending on the particular portion of the Industry more or less regulatory engagement is merited. I have identified 3 basic levels of regulatory engagement:

  1. Awareness is the most basic level of engagement and is simply being aware of the applicable rules and regulations impacting the economics of the industry as well as potential regulation under consideration.
  2. Understanding is taking the time to study policy and laws and form views and develop investment theses based upon regulatory policies and laws.
  3. Regulatory Engagement seeks to influence development and implementation of laws and policy. Most industries spend monies seeking to inform, influence and shape markets to benefit them. Figure 2. is data from opensecrets.org on lobbying monies spent from 1998-2011 by top spending industries.

Figure 2. Top Sectors Lobbying Spend

Source: http://www.opensecrets.org

From Figure 2. we can see that Energy sectors were among the top investing sectors investing in political capital. I think it’s safe to assume that the majority of the investment is done by the current established base and that renewables is a minor fraction. And what are established competitors receiving for their investment? Subsidies- lots of them (See Figure 3.) The World Energy Outlook for2011 estimated that there were about $409 billion in fossil-fuel consumption subsidies in 2010. For the investor in alternative energy, this is a clear signal that while venture capitalists are plowing limited partner (and general partner) investments into new systems, the incumbents are investing a lot less dollars in political capital for a significant return.

Figure 3. Subsidies for Fossil Fuel Companies

Source: World Energy Outlook 2011

Investment thesis 4: You’re Not Getting Better, You’re Getting Older

The energy markets are mature. In 1891 the first 3-phase ac electrical distribution network was deployed in Frankfurt, Germany. One consequence of this maturity is that there is little economic margin for new entrants with new technology to capture outsized profits while incumbent competitors play catch-up. It is my view that innovation is rewarded by outsized, initial profits for new businesses that deliver new products and services. These initial profits serve to compensate new businesses for the lack of capital in balance sheets as well as provide incentives to investors and entrepreneurs. In mature markets where there is little reward for innovating, it may not be economically rational to invest financial and human capital.  This places an even greater pressure on entrepreneurs as near-zero economic margin translates into near-zero margin for error in the managing the business. Mistakes that may be recoverable in other nascent and developing industries are not likely to be excused in a mature, well understood industry like energy. Investors in energy must be aware that on the job training for first-time entrepreneurs will likely carry very high tuition rates. Also, successful venture investments may have capital returns moderated due to the margin structure of the industry. I believe that there are pockets of higher margin business investments but must be carefully selected to capture these profits.

Another consequence of market maturity is the presence of the “super-competitor” in the form of incumbents. In the oil industry there are the “oligarchs” that are essentially unassailable. Untouched, these behemoths do as they please and have little to no competitive risk profile due to a global transportation infrastructure that is daily dependent upon them. The same forces that propel our Global Economy forward discussed in Part 1 of this series give this group of companies almost unlimited free reign from a competitive standpoint. On the electrical generation side, utilities that transform coal and gas and uranium into electricity are mostly regulated and therefore dominate the channel. The only way to reach the customers is either to make peace with the incumbent or to appeal directly at a grass roots, direct sales channel. With utilities struggling with customer engagement it is a massive task for a start-up company to attract customer interest let alone serve the volume of customers. Should a start-up be fortunate enough to attract the attention of an incumbent, then the sales cycle will likely be long, arduous and invasive. Any investment into an energy company at any level needs a clearly defined channel strategy that steers into the competitive dynamics of the industry.

It’s Always Darkest Before Dawn

For the investor in Energy 3.0, the challenges are large. While energy appears to be a limitless, unquenchable demand curve it also reflects a commodity market structure. On top of this, there is a strong political and regulatory dimension that is very difficult to break into. Not to mention the competitive advantages of large subsidies for the consumption of fossil fuel sources and regulatory barriers for new entrants. On top of this Energy is not a highly profitable business making the process of raising capital even more challenging. Energy 3.0 is a daunting investment environment to say the least.  (Please do not try this at home- these are professional investors in a closed environment.) But before we abandon Energy 3.0 stay tuned. There are still yet 3 more investment theses to review and they offer not only solace to the Energy 3.0 investor but I believe they point to the direction in the near term (1-5 year window)  as well as more general direction for the longer term (10+ years.)