ryptocurrencies are a hot topic and have divided opinion among economists, fund managers and even central bankers. Despite what the consensus opinion may or may not be, it is the technology called ‘blockchain’ on which cryptocurrencies run that could truly make a difference.
It has been said by various commentators that blockchain will do for transactions what the Internet did for information. This means it will allow increased trust and efficiency in the exchange of almost anything. Blockchain could profoundly change how the world works.
“Almost anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved.”
What is Blockchain?
Blockchain is a shared, distributed ledger that facilitates the process of recording transactions and tracking assets in a business network. An asset can be tangible – a house, a car, cash, land – or intangible such as intellectual property, patents, copyrights, or branding to name just a few. Almost anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved. Blockchain technology represents a more efficient way of verifying transactions. It describes a process of forming and linking blocks of cryptographically (encrypted for the layman) signed data to form an unchallengeable and perpetual database of records.
“Blockchain” is often used interchangeably with the term distributed or decentralised ledger – it is both. A distributed ledger, or digital database, helps to spread computing power needed for verification authority across multiple locations, also known as nodes, in a network. A decentralised ledger allows nodes to make independent processing decisions without considering decisions from other network nodes. A distributed and decentralised ledger is a type of shared database where all nodes independently reach decisions then work together to reach a consensus, which helps to maintain the integrity and accuracy of the database. The blockchain architecture gives participants the ability to share a ledger that is updated, through peer-to-peer replication, every time a transaction occurs. Peer-to-peer replication means that each participant (node) in the network acts as both a publisher and subscriber. Each node can receive or send transactions to other nodes, and the data is synchronised across the network as it is transferred.
Centralised Ledger Network
Decentralised Ledger Network
What is wrong with the current system?
Blockchain has come to prominence due to the need for an efficient, cost-effective, reliable and secure system for conducting and recording financial transactions.
Throughout history, instruments of trust (minted coins, paper money, contracts etc.) have emerged to facilitate the exchange of value and protect buyers and sellers. Important innovations (telephone lines, credit card systems, the internet) have improved the convenience, speed and efficiency of transactions all the time shrinking and sometimes virtually eliminating the distance between buyers and sellers.
However many business transactions remain inefficient, expensive and vulnerable, suffering from some of the following limitations:
- Cash is useful in local transactions and in relatively small amounts.
- Time – The time between transaction and settlement can be long.
- Duplication of effort and need for third party validation/presence of intermediaries add to the inefficiencies.
- Fraud, cyberattacks and even simple mistakes add to the cost and complexity of doing business and expose all participants in the network to risk if a central system, such as a bank, is compromised.
There is no question transaction volumes worldwide are growing exponentially and will surely magnify the complexities, vulnerabilities, inefficiencies and cost of the current systems. The growth of ecommerce, online banking, in-app purchases and the mobility of people around the world have grown transaction volumes significantly. This is just the beginning, with the rise of ‘Internet of Things’ the amount of transactions will only increase. This only highlights a small part of a larger issue that can be improved through the application of blockchain.
“There is no question transaction volumes worldwide are growing exponentially and will surely magnify the complexities, vulnerabilities, inefficiencies and cost of the current systems.”
How a blockchain works
The example above highlights how blockchain works using money as the object of the transaction. It can of course be any tangible or intangible object.
Each block contains a hash (digital finger print or unique identifier), time stamped batches of recent valid transactions, and the hash of the previous block. The previous block hash links the blocks together and prevents any block from being altered or a block being inserted between two existing blocks.
In this way, each subsequent block strengthens the verification of previous blocks and hence the entire blockchain. This method renders the blockchain tamper-evident, lending to the key attribute of immutability.
While Bitcoin may be blockchain’s poster child, it is important that we understand the scope of blockchain’s potential uses and important role it may play in our everyday lives. It is certainly not diffucult to imagine a scenario in which contracts are embedded in digital code and stored in transparent, shared databases, where they are protected from deletion, tampering, and revision. A future where every agreement, every process, every task, every vote and every payment would have a digital record and signature that could be identified, validated, stored, and shared. Individuals, organizations, machines, and algorithms would freely transact and interact with one another almost seamlessly. This is the immense potential of blockchain – it could revolutionise the structure of our financial, legal and political systems.
The applications of blockchain
Blockchain technology should have the potential to impact many industries and activities where there is a need to verify transactions with a high level of speed while reducing cost. Many large corporations have started investing large sums of money to forward block chain technology. This investment and the future potential applications of blockchain across many different sectors are highlighted in the table below.
Capital Markets & Securities Servicing
Trade Finance & Transaction Banking
Distributed Energy & Smart Grids
Record & Identity Management
Internet of Things
Big Data & Data Storage
Financial management & accounting
Smart Contracts, Property & Leasing
Proof of Ownership – Legal & Artistic Applications
Key characteristics of blockchain
The potential applications for blockchain are vast and, although it may be sometime until we actually see it implemented in everyday life, it is starting to be seen more frequently. Sierra Leone recently carried out a presidential election that used blockchain technology to verify the result and ensure voter fraud was not possible.
For a transaction to be valid all participants must agree its validity
Participants know where the asset came from and how its ownership has changed over time
No participant can tamper with a transaction after it has been recorded to the ledger. If a transaction is in error a new transaction must be used to reverse an error, and both transactions are then visible.
Each blockchain, is distributed: it runs on computers provided by volunteers around the world; there is no central database to hack or shut down.
For a transaction to be valid all participants must agree its validity
A single, shared ledger provides one place to go to determine the ownership of an asset or the completion of a transaction.
Blockchain is encrypted: it uses heavy-duty encryption involving public and private keys (rather like the two-key system to access a safety deposit box) to maintain virtual security.