What a Distributed Ledger Really Is
A distributed ledger is simply a database that exists in multiple locations. These locations are typically referred to as nodes. Each node contains a full copy of the ledger and collaborates with other nodes to validate changes. All changes to the distributed ledger must be agreed upon by all nodes prior to being added to the ledger.
One of the primary characteristics of distributed ledgers is their lack of reliance upon a centralized administrator. Instead, control of the distributed ledger is held by the collective group of users who access and update the ledger. As such, distributed ledgers contain fewer single points of failure than traditional databases, and users cannot independently modify the content of a distributed ledger.
Blockchain is a type of distributed ledger. A blockchain is organized in a manner that places information in blocks that are linked to each other in chronological order. Each block includes a reference to the previous block (i.e., the preceding block). As such, each block forms a part of a continuous chain of blocks. The nature of the blockchain creates continuity and provides clear evidence of any tampering or unauthorized modification to the blockchain.
Key Properties of Distributed Ledgers
Distributed ledgers have several characteristics that make them ideal for environments where either trust does not exist or the complexity of coordination is high.
- Distributed ledgers provide records to be shared among multiple parties rather than being held at a single point.
- Any update to the information contained in the record requires approval from other participants as defined by predetermined rules.
- All historical data remains available to allow for verification.
- Because each participant has a copy of the entire history of the records, system resiliency is increased because no single participant controls the ledger.
How Blockchain Data is Structured
Data within a blockchain is arranged into blocks. Each block will contain a list of transactions or records; a date/time stamp; and a reference to the preceding block that utilizes a cryptographic hash function to generate it.
The hash function plays a major role here. The output of a hash function changes when even a small amount of data in the input changes. Therefore, if someone attempted to alter a single block in a long blockchain, they would need to recalculate all of the subsequent blocks in order to create a valid chain of blocks. However, with most large-scale networks, such an undertaking would be extremely difficult (if not impossible) due to the computational resources required.
New blocks are added sequentially to the end of the existing blockchain. As blocks are added to the blockchain, it continues to grow in length and provides a complete history of all transactions that have occurred. This configuration allows users to track the origin of specific records through the blockchain.
Consensus Mechanisms and Network Agreement
Consensus mechanisms outline the procedures used by members of a blockchain network to determine whether or not proposed data additions to the blockchain should be accepted and incorporated. Because there is no central authority managing the blockchain, the consensus mechanism must ensure that all members agree that the proposed data addition is accurate.
There are many different types of blockchain consensus models, and the type chosen can affect how fast a blockchain operates, how much energy is consumed by the blockchain, and what level of security is assumed. Regardless of the specifics of the model, the primary goal of all consensus mechanisms is to protect against fraud and maintain consistency throughout the blockchain.
Common Consensus Approaches
Each consensus model is a balance of trade-offs, some favoring decentralization and others favoring efficiency. Ultimately, this decision will be based upon the goals of the network.
- Proof of Work utilizes computational power to both verify the validity of each block in the blockchain and to prevent malicious activity from occurring.
- Proof of Stake utilizes the total value of the assets held by participants in the blockchain network to determine who has the right to validate each new block in the blockchain.
- Delegated Models give the right to validate new blocks in the blockchain to a group of validators elected by the voting participation of the stakeholders within the network.
- Byzantine Fault Tolerant Systems utilize the established relationships among all participants in the network and ensure that there is an agreement regarding which block in the blockchain is valid.
Decentralization and Its Practical Meaning
The concept of decentralization is sometimes used interchangeably with the concept of “the lack of control.” However, in practical terms, the term decentralization refers to the spreading of authority over the network. In a decentralized blockchain, the determination of which transactions are valid and which rules should be applied is made by no single participant.
As such, this distribution of authority reduces the level of reliance that participants have on trusting other participants. As long as participants understand the rules of the system and believe that other participants will adhere to those rules, they do not necessarily need to personally know or trust individual other participants.
Decentralization occurs along a continuum. At one end of the continuum are fully open systems, where any person or organization can join the network.
At the opposite end of the continuum are permissioned systems where the network is restricted to only those organizations or individuals that have been pre-approved. Both types of systems make use of blockchain technology; however, they are typically being used to support two very different use cases.
Smart Contracts and Programmable Logic
Smart Contracts add functionality to blockchain beyond simply providing a means to keep track of records. Smart Contracts are computer programs that reside on the blockchain and are programmed to take action whenever certain criteria are satisfied.
Once a Smart Contract has been deployed onto the blockchain, it operates strictly in accordance with its programmatic instructions, and does so without human oversight.
Smart Contracts provide the ability to create complex interactions. For example, payments may be triggered by the occurrence of specific events. Access rights may be changed based upon predetermined criteria. Agreements may be enforced by the Smart Contract without the necessity of a third-party intermediary.
Because Smart Contracts operate on the blockchain, their execution is both transparent and auditable. Therefore, prior to interacting with a Smart Contract, participants can view the logic contained within the contract.
Characteristics of Smart Contracts
The potential for errors in the coding of smart contracts should not be overlooked. Smart Contracts have the capability to produce results that were unforeseen by the developer; therefore, changes to the smart contract's code may be problematic upon deployment.
- Smart Contracts are programmed to perform specific tasks or functions based on the satisfaction of predetermined conditions.
- Smart Contract logic is recorded on the Blockchain and executed in a consistent manner among all nodes on the network.
- Changes to Smart Contract Logic typically necessitate redeployment of the Smart Contract.
Tokenization and Digital Assets
Tokenization is the process of representing value or rights as digital tokens on a blockchain. Digital tokens can represent currency, access to services or resources, ownership of an asset or other forms of utility within a system.
Blockchain tokens can be programmatically created with rules that govern how they can be transferred, utilized, or supplied. These programmable rules create opportunities for new economic models.
Tokens can also represent physical world assets such as real estate property titles, commodity rights, intellectual property rights, etc., through the use of digital records that reference these physical world assets. However, the relationship between the digital record and the physical world asset is dependent on both the applicable laws and governance structures external to the blockchain.
Security Through Cryptography
Security within a blockchain is based on cryptography. The combination of public and private key pairs provide the means to authenticate users attempting to access or manipulate assets or take actions. Private keys are used to sign transactions, which are then verified using public keys.
This mechanism prevents unauthorized parties from taking action and creates a form of non-repudiation; thereby, making it difficult for a user to deny participation in an event after the fact.
Additionally, cryptographic techniques ensure that the integrity of the data within a blockchain remains unaltered once the data has been confirmed.
Transparency and Privacy Balance
Blockchains are often characterized as being transparent. However, this transparency does not necessarily equate to complete visibility of individual identities. Most blockchains will publish transaction data while obscuring personally identifiable information.
This equilibrium provides a level of verification for participants to assess the validity of transactions without exposing sensitive information regarding the individuals involved. Techniques to enhance privacy continue to develop and address issues related to exposure of sensitive data.
There are various types of blockchains, each with its own approach to how much information will be shared (i.e., open vs. confidential). The approach taken by the creators of the blockchain will be dependent on their desired application.
Governance and Protocol Rules
The two primary elements of systems that include blockchain are the protocol (the "rules" for how participants, validators, and update mechanisms interact) and governance (how those rules will evolve).
Blockchain-based systems can either be governed through an open process where the community develops and votes on proposals or through a closed system where an organization defines the process and who participates.
While governance plays a critical role in helping to ensure that blockchain based systems remain stable and adaptable, poor governance can lead to either fragmentation within the network or a breakdown in trust.
Energy Use and Efficiency Considerations
Another key aspect of blockchain-based systems is energy efficiency. As blockchain continues to grow and be adopted by organizations, the energy consumption of various consensus algorithms will continue to vary greatly. While there are consensus mechanisms that require a large amount of computational resources, other consensus mechanisms have been developed to consume fewer resources.
As such, many organizations are considering the long-term implications of energy consumption when developing their blockchain strategy. In order to meet these challenges, organizations are exploring new ways to develop blockchain-based systems that reduce the negative environmental impacts associated with the increased energy consumption.
Real-World Applications Beyond Currency
Beyond the financial industry, blockchain technology is being used to improve operational efficiencies in several different industries. For example, blockchain can be used to create supply chains that are more transparent. This creates more opportunities for stakeholders along the supply chain to be able to track products throughout their life cycle.
Similarly, identity management systems are being developed using blockchain. These types of systems allow users to maintain more control over their personal identifiable information. Furthermore, blockchain-based financial infrastructure can provide additional resiliency in the event of disruptions.
The common element among all of these examples is that they rely on a shared record and established set of rules. However, the establishment of a shared record and rules does not necessarily mean that the complexities associated with managing the record and establishing the rules have diminished.
Challenges and Limitations
One of the biggest limitations of blockchain technology is that it is not a one-size-fits-all solution. There are still scalability concerns for certain blockchain-based systems. Additionally, integrating blockchain into existing systems can be problematic. Lastly, regulatory ambiguity surrounding blockchain technology also hinders its adoption.
Therefore, understanding the limitations of blockchain technology is an important part of responsibly using it. Organizations should assess whether blockchain-based solutions address a particular problem rather than adopting it by default.
A Greate Combination
Blockchain technology combines a myriad of qualities to create a unified system where each element is dedicated towards improving transparency, integrity and coordination, all without central control. The interaction between these components improves blockchain application in the real world and how to use them to create lasting value.