Blockchain is a tamper resistant, self-sustaining, peer-to-peer technology for managing and recording transactions with no third party (central bank or clearinghouse) involvement.
The blockchain is primarily tamper resistant by timestamping the hash of batches of recent valid transactions into “blocks”), proving that the data must have existed at the time. Each block includes the prior timestamp, forming a chain of blocks, with each additional timestamp reinforcing the ones before it, thus giving the database type its name. Each block chain record is enforced cryptographically and hosted on machines working as data store nodes extending this validation to the network as a whole.
Because blockchain verification is handled through algorithms and consensus among multiple computers, the system is presumed immune to tampering, fraud, or political control. It is designed to protect against domination of the network by any single computer or group of computers. Participants are relatively anonymous, identified only by pseudonyms, and every transaction can be relied upon. Moreover, because every core transaction is processed just once, in one shared electronic ledger, blockchain reduces the redundancy and delays that exist in today’s banking system.
The Blockchain technology that underlies Bitcoin has potential to be applied to a wide variety of derivative solutions to complex financial instruments. A blockchain based system creates essentially a “TrustNetwork” that uses cryptographic signatures and hashes for idempotent events creating an immutable historic ledger by default. Decentralized computational power with distributed trust based on mathematical truth can create indisputable contracts, transactions, currency, etc.
How a Blockchain works in an cryptocurrency example
The Dynamics of a Blockchain (Distributed Ledger)
The core advantages of the blockchain architecture include the following:
- The ability for a significant number of nodes to converge on a single consensus of the most up-to-date version of a large data set such as a ledger, even when the nodes are run anonymously, have poor connectivity with one another, and have operators who may be dishonest or malicious.
- The ability for any node that is well-connected to other nodes to determine, with a reasonable level of certainty, whether a transaction does or does not exist in the confirmed data set (see consistency).
- The ability for any node that creates a transaction to, after a certain period of confirmation time, determine with a reasonable level of certainty whether the transaction is valid, able to take place, and become final (i.e. that there were no conflicting transactions confirmed into the block chain elsewhere that would make the transaction invalid, such as the same currency units “double-spent” somewhere else).
- A prohibitively high cost to attempt to rewrite or alter any transaction history.
- An automated form of resolution that ensures that conflicting transactions (such as two or more attempts to spend the same balance in different places) never become part of the confirmed data set.
A blockchain implementation consists of two kinds of records: transactions and blocks.
- Transactions are the actual data to be stored in the block chain
- Blocks record and confirm when and in what sequence transactions became journaled as a part of the block chain database.
Transactions are created by participants using the system in the normal course of business and blocks are created by users known as “miners” who use specialized software or equipment designed specifically to create blocks. In the case of cryptocurrencies, a transaction is created anytime someone sends cryptocurrency to another.
Users of the system create transactions which are loosely passed around from node to node on a best-effort basis. The definition of what constitutes a valid transaction is based on the system implementing the block chain. In cryptocurrency applications, a valid transaction is one that is properly digitally signed, spends one or more unspent outputs of previous transactions, and the sum of transaction outputs does not exceed the sum of inputs.
Meanwhile, miners attempt to create blocks that confirm and incorporate those transactions into the blockchain. In a cryptocurrency system such as bitcoin, miners are incentivized to create blocks in order to collect two types of rewards: a pre-defined per-block award, and fees offered within the transactions themselves, payable to any miner who successfully confirms the transaction.
Impact and Innovation
If you are a senior executive in a financial-services firm, you may already be experimenting with distributed ledger technologies, if only to see how they fit with your strategy. You have lots of company. By 2014, more than a dozen major companies were actively exploring blockchain-related ventures and their potential effect on core practices (Exhibit 2). For example, blockchain might streamline transaction processing by establishing a single source of truth, available to all, updated in near-real time. This could increase the speed of exchange, reduce the number of intermediaries (and the costs associated with them), improve security, digitize assets, give wider access to people who don’t have bank accounts, enable better bookkeeping, and improve regulatory compliance.
Financial Institutions and other Major Companies exploring Blockchain
The technology could also be used to create and support “smart contracts”: code-based, defined sets of rules that sit on top of a blockchain database, and that execute only when specific actions occur. Eris Industries, a software firm that created one of the first blockchain-based platforms for this application, describes smart contracts as modular components, similar to apps on a financial network, which can be combined to provide verifiability to any type of transaction. According to the Eris website, the uses could be “as simple as up-voting a post on a forum, to the more complex such as loan collateralisation and futures contracts, to the highly complex such as repayment prioritisation on a structured note.”