28 April, 2016
Distributed ledger technology, or block chain, is best known as the technology which underpins Bitcoin, the world’s most successful cryptocurrency to date. Initially treated with some scepticism as a niche application, it is fast becoming viewed as the most disruptive technology in decades. Beyond its obvious applications in financial services, government services, smart contracts and cybersecurity, it could fundamentally change the way society operates. No wonder that governments are desperate to get ahead of the curve and, quite literally, harness its potential.
WHAT IS BLOCK CHAIN?
The terms ‘block chain’, ‘blockchain’ and ‘distributed ledger technology’(“D LT”), are used more or less interchangeably. The technology provides a way of creating a shared ledger or database which can record and track transactions and assets. Each participant sees the identical copy of the ledger in close to real time.
The rules built into the system determine what constitutes a transaction.
Transactions are passed around nodes. Records of transactions are aggregated into blocks by ‘miners’ once the transactions have been verified by using computational power to assure all members of the network that the transaction has taken place according to the system’s rules. The purpose of mining is to allow nodes to reach a consensus about the validity of the transaction. In theory, anyone with a computer can become a miner by installing some software but the processing power required to crack the code in order to add a new block to the chain is enormous. Small- time miners will often pool together but some miners take the form of large data centres. Incentive to become a miner is usually provided; Bitcoin rewards its miners with (unsurprisingly) Bitcoins.
Once a consensus has been reached about the transactions in a block, it can be linked to another block by a ‘chain’ using a cryptographic signature. A new block can only be added to the chain once the transactions are authenticated and the cryptographic puzzle in the previous block has been solved in order to link the new block to it.
STRENGTHS
Resilience to fraud is one of the technology’s main features. Anyone attempting to alter a ledger would have to redo all the calculations carried out to add the transaction in question to the block chain. They would also have to redo all the calculations for the blocks which followed and then be the first to crack the newest block and have it accepted into the chain. For the moment, at least, this is thought to be impossible.
To alter the Bitcoin system, for example, it is estimated you would need to control 51% of the computing power of the miners of the system.
Having said that, Bitcoin miners are already reportedly suffering from cyberattacks which are putting pressure on current systems.
Distributed ledgers are shared but no single user controls them. Participants in the ledger keep it up to date and can only amend it according to the pre-programmed rules of the system and with the consensus of at least some of its other users. This means that the ledgers can be both public and secure. A distributed ledger can be permissioned which means a single or a select group owns it and verification is carried out by a limited pool of consensus providers. It is also possible to create hybrid ledgers so you could have a block chain ledger as an underlying database with top layers of permissions for different types of users. Alternatively, the ledger can be unpermissioned like the Bitcoin ledger. It is open source, anyone can contribute to it and nobody can prevent a block being added once consensus has been reached.
The distinction between permissioned and unpermissioned ledgers is likely to be a crucial one in the development and practical application of block chain technology. The key strengths of block chain are that its ledgers are a shared but secure record of transactions and ownership which updates more or less in real time and which shows a complete history. The Bitcoin ledger, for example, shows every single Bitcoin transaction which has ever taken place.
The capacity to do away with the need for intermediaries is one of the greatest attractions of distributed ledgers. Because all transactions are verified before they are added to the chain, there is far less need for a central trusted third party or a central bureaucracy to facilitate operations. In addition, other information beyond the details of the transaction can be added so that, for example, it is not merely an event which is recorded but details of ownership or other personal records.
With permissioned ledgers, all participants start off as trusted users which reduces the need for sophisticated mining.
The decentralised control of unpermissioned ledgers makes them particularly resilient to cyber attack and the potential for pseudonymisation (if not anonymisation) of players provides inbuilt data protection. Both these aspects can be strengthened or weakened depending on the nature of the ledger and its permissions. One of the benefits of block chain technology, especially when combined with other database technology, is the high degree of control it offers users.
For example, an individual could give data to HMRC and various other government agencies but the individual could control which data could be seen by which agency and would also be able to track access to and
use of that data.
APPLICATIONS
Finance
– The most obvious applications are in the world of financial services which cannot be manipulated or unlawfully altered to record financial transactions is easy to see and the reduced administrative cost associated with genuinely digitised banking is proving very attractive to banks. Leading banks are collaborating in R3 CEV, a joint venture aimed at developing standardised private ledgers to be used in the banking industry and trials have already started.
Government
– Government is looking at a range of applications for block chain technology, particularly with a view to reducing bureaucracy.
The means for government agencies to securely share information across departments is enticing. Welfare distribution, healthcare, tax collection, contract management, property ownership, reduction of fraud, protection of critical infrastructure and distribution and control of international aid, are all highlighted by the UK government as areas which would benefit from the use of distributed ledgers. In addition, they offer the potential for a more inclusive form of government, whereby individuals could vote more frequently or give voting instructions to local MPs in an easily transmittable and recordable manner.
Smart contracts
– It is not just in government that the use of so- called ‘smart contracts’ is being explored. Block chain technology offers the possibility of using smart contracts across the whole range of businesses. Ethereum, for example, is a start up whose distributed ledger can carry more data than the Bitcoin one. It allows users to create relatively sophisticated smart contracts, for example, invoices which pay themselves when a product arrives, or share certificates which distribute dividends to shareholders automatically when profits reach a certain level.
Asset tracking
– While block chain technology started off with a somewhat shady reputation, with Bitcoin viewed as a payment mechanism for criminal activities, block chain technology actually provides huge potential to reduce fraud and track provenance. Assets like art and jewellery are traditionally tracked manually with paper documents used to prove origin. Both the artefacts and the records are open to forgery. Block chain offers the means for higher forms of verification and tracking. Everledger is a leading example of using block chain technology to track assets, in this case, diamonds. It creates an electronic identify for each diamond, assigns it a digital passport and then attaches that data to the transaction records held in the block chain. Asset tracking and sharing is also potentially useful for tracking and managing the internet of things with the particular benefit that doing so in a distributed ledger, rather than through centralised databases, is likely to protect from hacking and surveillance.
ISSUES
Notwithstanding the exciting potential of block chain, there are some considerable deficiencies in the block chain technology at the moment which include the fact that it relies on huge processing power and can only cope with a limited number of transactions per hour (seven Bitcoin transactions per second, compared with 1736 transactions processed by Visa America per second). As with any technology, there is the risk that it could be expensive to implement and that it could quickly become obsolete or incompatible with other technologies, especially if there is no agreement over which standards to use. If a standard is agreed or becomes the front runner, the controller of the standard could wield a vast amount of power. Another concern is what happens if consensus breaks down, particularly with unpermissioned ledgers. The controllers of Bitcoin are reportedly already in disagreement about how to reach consensus.
An overriding issue is how to regulate the use of block chain. Governments see a threat in unpermissioned distributed ledgers which are not centrally controlled and are trying to work out how to control their use without stifling innovation (see our article: Building blocks:
developing systems using distributed ledger technology – In the UK government’s recent report “Distributed Ledger Technology: beyond block chain”, an entire section is dedicated to the disruptive potential of the technology: “DLTs pose a threat to any hierarchical structure through an ability to connect and operate in a distributed network, without trusted or necessary intermediaries, by replacing top-down control with consensus. Hierarchies can have significant disadvantages…but do offer advantages wherever a neutral broker is needed; and, for example, in representative democracy…
The challenge will be to ensure that DLT and its associated innovations are directed towards a connected productive society within a supportive infrastructure."
At the moment, democracies create their rules through a legislative process. These rules are interpreted and enforced by people. Block chain technology allows for people to be replaced by programming. For the foreseeable future, the programming will still need to be carried out by people but not necessarily by elected representatives. Bitcoin, for example, is controlled by a handful of people who developed the technology and the product. Governments are looking not only to harness the potential of the technology but also to control it without stifling it. For libertarians, a world in which control is taken away from centralised power structures is a thrilling one, but others are worried by the vision of a future in which ever more sophisticated computer programmes have the final say.
Much will depend on getting the balance between control and openness right, with permissioned ledgers likely to be favoured by many. Despite some significant shortcomings including the processing power needed for block chain ledgers and the current, relatively slow transaction rate, there can be no doubting the potential of this technology across financial services, business and government.
Perhaps though, at the very heart of the matter is a philosophical debate about how society should function.
Who makes the rules? Who controls the infrastructure?
Who can play the system?
While distrust of central government is prevalent across the world, whether in developed or developing nations, and a lot of people would cheer the demise of bankers and lawyers as intermediaries, perhaps what the debate actually boils down to is: who do you trust more – Man or Machine?
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