An Introduction to Blockchain
Blockchain uses a distributed ledger (the “Ledger”) which is a database shared, replicated, and synchronized among the participants of a network (“Participants”) wherein all transactions among the Participants is recorded.
Participants govern and agree by consensus on the updates to the records in the Ledger. There is no central third-party such as a bank. The Ledger has an auditable history of all transactions since each record has a timestamp and a unique cryptographic signature.
Traditionally, businesses come together at marketplaces where producers, consumers, suppliers, partners, and market makers exercise their rights to various assets. Assets can be physical, such a home, or intangible, such as a patent. Transactions may involve many parties, including buyers, sellers, and intermediaries whose business agreements and contracts are usually recorded in traditional ledgers. A business often uses many traditional ledgers to keep track of its assets and its asset transfers.
Traditional business ledgers are inefficient, costly, opaque and subject to hacking. These issues stem from centralized, trust-based, third-party systems, such as financial institutions. Centralization leads to bottlenecks and slowdowns of transaction settlements (i.e. full completion of a transaction such as completion of a wire transfer). Lack of transparency and susceptibility to fraud may lead to disputes; dispute resolution and resulting transaction reversals are expensive.
A blockchain is a Ledger that records transactions in a public or private network. Distributed to all Participants, the Ledger permanently records, in a sequential chain of cryptographic hash-linked blocks, the history of asset exchanges that take place among Participants. A hash is the complex result of a mathematical equation that both connects the blocks, and prevents tampering.
All confirmed and validated transaction blocks are linked and chained from the first to the last block – this is why it is called “blockchain”. The blockchain represents to all Participants the valid state of the Ledger.
To ensure the integrity of transactions, Participants use a consensus protocol to agree on ledger content, and cryptographic hashes and digital signatures. No third party, such as a financial institution, mediates transactions.
Consensus means that the shared ledgers are all exact copies and this lowers the risk of fraud since, for fraud to succeed, tampering would have to occur in many places. Cryptographic hashes ensure that any alteration to transaction input results in a dissimilar hash value, indicating potential tampering. Digital signatures are used to ensure that transactions actually originated from the purported senders who sign with their own secret private key.
Consensus is a collaborative process established by the Participants and used by the Participants to indicate that a transaction is valid and to keep the Ledger consistent among all Participants. Participants come to a consensus on the transaction and validate it before it is permanently recorded in the Ledger. No system administrator can delete a transaction once it has been added to the Ledger.
If there is a trusted network of Participants, such as within an organization or between trusted business partners, the costs of establishing consensus is low. Where trust is high, the consensus procedure may simply be a majority vote of the Participants. There are higher costs to the establishment of consensus in public, or permissionless, blockchains such as Bitcoin.
As no single Participant owns the information contained in the shared ledger, blockchain leads to increased trust in transaction information among the participating members. Blockchain also leads to lowered cost of audit and regulatory compliance, with improved transparency.
Smart contracts executed on business networks using blockchain are automated and final, resulting in increased speed of execution, reduced costs, and lowered risk. Smart contracts are terms agreed upon between parties that govern interactions with the Ledger. The contracts permit Participants to execute certain aspects of transactions automatically. For example, a contract might determine the price of an item that depends on when the item is received, resulting in the automatic pay out of funds.
Blockchain is a fundamentally new method to transact business. Blockchain’s decentralized consensus, cryptographic security and shared ledger may significantly alter the organization of business transactions throughout the world.