With so much chatter about “Blockchain”, it’s often hard to find a sensible resource with some sensible explanation and commentary.  We have tried to distill the most salient points here.

Key features

So what is blockchain? You have probably heard of Bitcoin, the online currency, but that’s not going to help you much.  The big deal with the underlying technology, blockchain, is the “distributed ledger” on which blockchain operates, that allows (a) faster transaction processing, (b) a permanent, distributed, immutable record of transactions to be stored, which leads to (c) greater security (potentially).

A crucial feature of this distributed approach is that there is no central owner of the ledger.  Many operators do ‘work’ to verify and validate the transactions that have been posted, with a 51% consensus on the result required to make that record permanent. Each block of ‘work’ (e.g. 10 minutes worth of transactions) builds on all previous blocks – hence the “chain” – and the permanence of anything laid down in this ledger. (See graphics below)

how-the-bitcoin-block-chain-works-Infographic

      Graphic: How the bitcoin block chain works Infographic source: BI

A huge advantage of blockchain is speed: transactions can be settled almost instantly and recorded in the open, distributed ledger, which can be seen and verified right away by all parties. There’s no batch processing, or bank clearing; the cost savings opportunity is huge – the Spanish bank, Santander, has outlined potential savings of $20bn annually with this technology.

However, the distributed ledger approach is a double-edged sword with respect to security. On the plus side, as the ledger is distributed amongst many anonymous actors, the permanence of records that have been laid down is ensured, since it would be essentially impossible to re-write history and amend current transactions across every single actor’s databases.

On the other hand, one can never be sure of malevolent actors finding a method of ‘cheating’ to get to 51% consensus.  It is theoretically possible for someone to set up lots of (apparently independent) servers acting in the transaction processing pool and for them to reach consensus on ‘false’ information, thereby allowing them to ‘cheat’, i.e. make up bogus transactions and steal value. This would however, be enormously expensive in terms of processing power.  With Bitcoin, the rewards for processing transactions (aka mining) is around $1m per day, and there are now so many actors mining that cheating here is not economically viable.

Asset ledgers: beyond currency

Using the blockchain approach for assets is now being seen as a way to maintain permanent records of non-currency exchange and ownership, e.g. a land registry or diamond ownership. This has been attempted using “coloured” or “watermarked” coins on a distributed network like Bitcoin, but in ascribing value to tokens that may be of much greater value than the transactions they are processing, this may then make the economics of ‘cheating’ worthwhile.  As such, adding a layer over a currency platform is inadvisable and unlikely to continue.

Non-currency-based blockchains are in development and are adopting new approaches to minimise the risk of malign parties, such as Permissioned-on-permissionless (P-o-P) blockchains, where users are required to undergo KYC/AML checks.  It is this distributed-amongst-trusted-actors, ring-fenced approach that is most likely to persist for asset ledgers.

Smart contracts: self-executing agreements 

A feature of blockchain is that pretty much any digital data can be stamped into it – set in stone if you like – which is great for an asset ledger, and can be extended to any contracts that you want to verify in the future, e.g. a landlord-tenant contract.  Further to this, is the possibility of embedding “smart contracts”, self-executing programmes that will perform certain tasks given certain inputs. For example, given a tenant’s payment into the blockchain, the smart contract can instantly pay the landlord and any commissions due, send out details to all parties, and record all relevant details in the ledger. The increased speed of the transaction is of clear benefit to all those seeking to get paid, whilst also allowing instant visibility on creditor stretch, with a permanent performance record forming over time.

The potential for the application of smart contracts has barely been recognised yet, but it is an area that is ripe to be exploited, given certain security concerns are addressed.

Summary

In conclusion, blockchain technology has many applications and a lot to offer, but it should be remembered that it is just a technology.  As with many early-stage technologies, how it is applied and implemented will define the benefits it yields and the drawbacks it carries.

 

Advantages: speed, distributed verification, permanent ledger

Drawbacks: potential security issues

 

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Sources:

“Watermarked tokens and pseudonymity on public blockchains” by Tim Swanson, Nov 2015

“The economics of digital currencies” by Ali, Barrdear, Clews & Southgate of the Bank of England Quarterly Bulletin Q3 2014

The trust machine” The Economist Oct 2015

How blockchain technology might decentralise everything” by Paula Newton, June 2015