Researchers and technologists alike are talking about how blockchain technology is the next big thing across industries from finance to retail to even healthcare. According to Gartner, their client inquiries on blockchain and related topics have quadrupled since August 2015.
What is Block chain and how it works?
A blockchain is a digitized, decentralized, public ledger of all cryptocurrency transactions. Constantly growing as ‘completed’ blocks (the most recent transactions) are recorded and added to it in chronological order, it allows market participants to keep track of digital currency transactions without central recordkeeping. Each node (a computer connected to the network) gets a copy of the blockchain, which is downloaded automatically.
Originally developed as the accounting method for the virtual currency Bitcoin, blockchains – which use what’s known as distributed ledger technology (DLT) – are appearing in a variety of commercial applications today. Currently, the technology is primarily used to verify transactions, within digital currencies though it is possible to digitize, code and insert practically any document into the blockchain. Doing so creates an indelible record that cannot be changed; furthermore, the record’s authenticity can be verified by the entire community using the blockchain instead of a single centralized authority.
Blockchain is the underlying technology behind cryptocurrencies like Bitcoin. Unlike physical currency, digital cash and cryptocurrencies come with a very real problem called Double-Spending. Taking an example to understand, let’s say I email you a picture of my cat, I’m sending you a copy and not my original picture. However, when I need to send you money online, as much as I would love to send you a copy of it, it’s a bad idea if I really do that! With Bitcoin, there was a risk that the holder could just send copies of the same bitcoin token in different transactions, leading to “Double-Spending”.
Blockchain technology helps counter issues like double spending. The simplest way to think of blockchain is as a large distributed ledger of sorts that stores records of transactions. This “ledger” is replicated hundreds of times throughout the public network so it is available to everyone. Every time a transaction occurs, it is updated in ALL of these replicated ledgers, so everyone can see it.
Every time a new transaction is initiated, a block is created with the transactions details and broadcast to all the nodes. Every block carries a timestamp, and a reference to the previous block in the chain, to help establish a sequence of events. Once the authenticity of the transaction is established, that block is linked to the previous block, which is linked to the previous block, creating a chain called blockchain. This chain of blocks is replicated across the entire network, and all cryptographically secured which makes it not only challenging, but almost impossible to hack. I say almost impossible because it would take some significant computational power to even attempt something like that.
The time when the block was found.
- Reference to Parent (Prev_Hash):
This is a hash of the previous block header which ties each block to its parent, and therefore by induction to all previous blocks. This chain of references is the eponymic concept for the blockchain.
- Merkle Root (Tx_Root):
The Merkle Root is a reduced representation of the set of transactions that is confirmed with this block. The transactions themselves are provided independently forming the body of the block. There must be at least one transaction: The Coinbase. The Coinbase is a special transaction that may create new bitcoins and collects the transactions fees. Other transactions are optional.
The target corresponds to the difficulty of finding a new block. It is updated every 2016 blocks when the difficulty reset occurs.
An arbitrarily picked number to conveniently add entropy to a block header without rebuilding the Merkle tree.
- The block’s own hash:
All of the above header items (i.e. all except the transaction data) get hashed into the block hash, which for one is proof that the other parts of the header have not been changed, and then is used as a reference by the succeeding block.
As many miners compete to find the next block, often there will be more than one valid next block discovered. This is resolved as soon as one of the two forks progresses to a greater length, at which any client that receives the newest block knows to discard the shorter fork. These discarded blocks are referred to as extinct blocks (sometimes also referred to as orphaned blocks, although their complete ancestry is known).
In the context of security, both transparency of the system and immutability of the data stored on blockchain comes into play. Immutability in computer science refers to something that cannot be changed. Once data has been written to a blockchain, it becomes virtually immutable. This doesn’t mean that the data cannot be changed – it just means that it would require extreme computational effort and collaboration to change it and then also, it would be very difficult to cloak it.
Blockchain technology can really be applied to not just a cryptocurrency like bitcoin, but to any “asset” that can be stored, distributed or transacted – property titles, music, insurance, physical goods and assets, even your data.
This technology has great implications for the financial services industry as well. On implementing a decentralized database or a public registry like blockchain to verify the identities of all parties, no longer will we need to have our transactions stay “pending” for three days. Settlement would be instantaneous since the transaction and settlement would happen simultaneously once the ledger is updated. There are many such use cases.
Benefits of blockchain technology?
The thought leaders of the world in the blockchain sphere offer numerous benefits of blockchain technology. That’s why we had to mention the top 8 benefits that are so much on all our minds.
This is a core concept and benefit of blockchain. There is no need for a trusted third party or intermediary to validate transactions; instead a consensus mechanism is used to agree on the validity of transactions.
Transparency and trust
As blockchains are shared and everyone can see what is on the blockchain, this allows the system to be transparent and as a result trust is established. This is more relevant in scenarios such as the disbursement of funds or benefits where personal discretion should be restricted.
Once the data has been written into the blockchain, it is extremely difficult to change it back. It is not truly immutable but, due to the fact that changing data is extremely difficult and almost impossible, this is seen as a benefit to maintaining an immutable ledger of transactions.
As the system is based on thousands of nodes in a peer-to-peer network, and the data is replicated and updated on each and every node, the system becomes highly available. Even if nodes leave the network or become inaccessible, the network as a whole continues to work, thus making it highly available.
All transactions on a blockchain are cryptographically secured and provide integrity.
Simplification of current paradigms
The current model in many industries such as finance or health is rather disorganized, wherein multiple entities maintain their own databases and data sharing can become very difficult due to the disparate nature of the systems.
But as a blockchain can serve as a single shared ledger among interested parties, this can result in simplifying this model by reducing the complexity of managing the separate systems maintained by each entity.
In the financial industry, especially in post-trade settlement functions, blockchain can play a vital role by allowing the quicker settlement of trades as it does not require a lengthy process of verification, reconciliation, and clearance because a single version of agreed upon data is already available on a shared ledger between financial organizations.
As no third party or clearing houses are required in the blockchain model, this can massively eliminate overhead costs in the form of fees that are paid to clearing houses or trusted third parties.
Hurdles in Adopting Blockchain Technology
The roadblocks to DLT today are not just technical. The real challenge is politics, regulatory approval, and the many thousands of hours of custom software design and front and back-end programming still required to link up the new blockchain ledgers to current business networks.
Problems that still need to be addressed include:
- DLT must interface with other parts of the operational processes seamlessly. Blockchain should enable more rapid setup, training, and reduce problem resolution time. Achieving the efficiency gains must be easy enough/cheap enough for all parties involved to grasp and leverage.
- Security also remains a concern. Several central banks, including the Federal Reserve, the Bank of Canada and the Bank of England, have launched investigations into digital currencies. According to a February 2015 Bank of England research report: “Further research would also be required to devise a system which could utilize distributed ledger technology without compromising a central bank’s ability to control its currency and secure the system against systemic attack.”
- Banks are not interested in an open-source model for identity. Both banks and regulators want to maintain close control. The development of a single digital identity passport authorizer is a critical next step.
- Regulation is also critical in creating an open digital environment for commerce and financial transactions. Current physical certificates must be digitized to gain the full benefits of a fully electronic system. Other questions to be answered include: Who is responsible for maintaining and managing the blockchain? Who admits new participants to the blockchain? Who validates transactions? and who determines who sees which transactions?
Think of all the different data sets, online and offline records and contracts that you have contact with on a daily basis, whether in your work or personal life. Now, think of all the complexities involved in analysing, cross-referencing and communicating between these different intermediaries, systems, contracts and agreements, whether that’s to check ownership, identity, authenticity or make a transfer of some sort. It’s work like this that keeps millions of accountants, lawyers and administrators in employment!
With blockchain, this complexity would – in theory – become a thing of the past because every transaction, contract and agreement would be automatically recorded, verified and centrally accessible. There would be no need for intermediaries, checks and bureaucracy to prove the trustworthiness or authenticity of your data, as it would be inherently secure and guaranteed. The reduced risk, would mean valuable cost and time-saving benefits in everything from payments to supply chain, government records to tracking taxpayer money. It would all be streamlined and integrated into one big super database.
This vision is why proponents of blockchain say it will revolutionise business processes across a range of sectors by removing duplication of effort, unnecessary processes, and guaranteeing greater integrity of data. In this picture, blockchain is the driver for new business models, improved risk mitigation and greater predictability within business. With all parties in a transaction verified by digital signatures, it could open the way to new trusted networks, markets and value.