Distributed ledger technology (DLT) constitutes shared distributed or decentralized digital ledgers implementing cryptographic algorithms to verify digitally represented assets or information over a peer-to-peer network. DLT operates via an innovative combination of distributed consensus protocols, cryptography and inbuilt economic incentives based on game theory.
DLT can also be used to represent, track and trade a plethora of assets and information including: (i) fiat money; (ii) stocks, bonds, derivatives and other financial products; (iii) real and intellectual property rights; (iv) contract rights; (vi) the expenditure of public or private funds; (vii) personal and sensor-based data and messages; (viii) the delivery of digital entitlements and digital identity to end-beneficiaries.
DLT has a myriad of innovative properties comprising a distributed consensus containing no central point of control or failure, transaction transparency and auditability and party identity abstraction contributing to enhanced privacy.
There are 4 basic types of DLT comprising public, permissionless Blockchains, private Blockchains, hybrid projects and hyperledger. Public chains use either proof-of-work or proof-of stake consensus algorithms, have developed open source protocol code and changes regarding the code are adopted by majority consensus. There are no official barriers to the entry, use, or viewing of a public, permissionless Blockchain and it has a multitude of beneficial features including right of access, security and transparent real-time public recordkeeping. Next generation public chains deploy advanced cryptographic techniques such as zero-knowledge proofs and ring signatures to enhance user privacy. Conversely, there are substantial concerns regarding the limitations of public Blockchain’s scalability.
Private, permissioned Blockchains are only accessible by parties who are approved to participate in transacting, mining, or viewing transactions and code can be either open or closed source. Private chains are a popular solution among consortiums of stakeholders with shared interests and have a magnitude of benefits comprising controlled amounts of node network participation and issuance of confidentiality agreements among approved participants. Antithetically, limitations include restricting access to trusted participants subject to regular auditing.
Hybrid blockchains are a combination of public and private blockchains and can be configured to be private for users and miners and public for viewers and utilize a composite of open and closed-source code. Their primary advantage is flexibility as features can be tailored to specific classes of users, actions or information and limitations consist of specificity and complexity creating significant barriers to interoperability that may subsequently transpose to lock-in effects and inhibit healthy competition.
The IOTA tangle is an innovative type of distributed ledger technology implementing Directed Acyclic Graphs (DAGs) to transmit and confirm transactions using asynchronous rather than chained methodology. In contrast to the private chain Tangle has no dedicated miners and prominent advantageous are zero transaction fees and the transaction of sub-cent values peer-to-peer performed without senders or recipients incurring fees. Furthermore, Tangle scales organically becoming more efficient as network traffic compounds and the distributed consensus protocol additionally enables it to be partition tolerant. Conversely, limitations include lack of miners as it must strategically select transactions it seeks to confirm deploying a Markov Chain Monte Carlo Random Walk algorithm and is therefore not entirely decentralized.
Distributed ledgers clearly have significant beneficial features including decentralized information management and contribute to an immutable secure and private record. DLT also reduces third party reconciliation while concurrently limiting complexity, increasing transaction processing efficiency and improving network resiliency as unilateral changes are prohibited.
DLT can evidently provide efficiency, trust and data reconciliation gains among ledger participants and participants capitalise on the immutable record as added data is unamenable and preserved. Participants can also utilize nodes that interact directly without intermediaries and initiate direct data transactions.
Potential benefits offered by immutable record of transactions include providing a clear financial trail for auditors and enabling regulatory compliance through smart code rather than legal code. It can also improve transparency by providing a trail of transactions in permissionless ledgers and reduce data error and fraud.
DLT solutions are evidently applicable for a large proportion of industries yet will have to overcome cultural resistance by market incumbents to achieve wider market acceptance by implementing established sector specific technical and operational standards to deter high initial implementation costs. The adoption of DLT by existing industry incumbents could furthermore eradicate new market entrants and create significant barriers to market entry.
The removal of intermediaries and rapid efficiency and automated contract processing growth may contribute to new areas of unforeseen risk, particularly in the financial sector, by encouraging herding behaviours. It may also alter the nature of financial interactions in low risk sectors such as insurance and government treasury bonds and monitoring systemic risk could become more ardous. Additionally, placing assets on DLT can have consequences regarding market liquidity and a subsequent liquidity increase by increasing settlement speed, or decrease, by locking in collateral in a smart contract or requiring higher collateral by reducing position netting.
DLT has notable limitations such as the potential for different types of ledgers to develop into silos and there are considerable fragmented DLT systems competing that each have proprietary, non-interoperable standards and protocols, raising challenges for competition. Further limitations involve inconsistent technological development contributing to the fragmented market, and it’s clear wider industry DLT adoption depends on enabling seamless interaction between DLT systems and current/legacy systems.
DLT’s pronounced differentiation to legacy systems is highlighted by the disintermediation of trust as legacy systems often have single point, centralised mechanisms of verification and security.
Salient limitations also involve the maintenance of data integrity and security stored on a ledger and data relating to the transaction activity. For a multitude of ledgers, a transparent record can be incorporated and contains the ability to restrict participants’ ability to access sensitive or commercial data.
DLT adoption produces sizeable opportunities and the distributed nature of technology not owned by a single entity enables participants to retain their own copy of data and transactions to prevent failure. This amounts to a magnitude of business practice improvements, such as cost reduction operaionally, increased resilience in transactional systems and the facilitation of applications such as digital identity management and smart contracts.
DLT evidently increases end-users’ trust and assists with efficiency gains as sectors currently relying on trusted third-party intermediation could experience improved cost removal, transactional efficiency and novel revenue streams. DLT can enhance usage costs and value gains, enabling companies to pay for infrastructure in real time according to usage and value attained. DLT can furthermore replace paper-based processes, reducing costs and reliance on paper and increase data intensive transactions efficiency and transparency.
DLT also contributes to new forms of business collaboration such as multiple participants issuing individual lines of code to a programme while retaining copyright for their discrete contribution or creating ledger-based organisations governed by implementing smart contracts.
DLT has the overarching ability to facilitate transactions without relying on proprietary infrastructure, therefore reducing costs and its adoption within an enterprise or across multiple stakeholders can cause significant efficiency gains as it adjoins fragmented silos. The opportunity to transfer assets without third-party intermediaries could irrefutably provoke exponential growth in peer-to-peer transactions and moreover facilitate the sharing economy.
