What is distributed ledger technology?
While often confused with each other, “blockchain” and “distributed ledger” are disparate, yet related terms. Blockchain is a type of “distributed ledger,” or database that is consensually shared and maintained by multiple nodes, or computers that run blockchain software to validate and store a complete history of network transactions. Each node maintains an identical copy of a ledger, and blockchain organizes the information into blocks, which are chained together.
Interest in distributed ledger technology has grown significantly in the past decade, with several organizations across different industries experimenting with its deployment on an enterprise scale. Financial services, healthcare, and pharmaceutical companies were among the first to adopt distributed ledger technology. Among its benefits is decentralization, which may provide better protection from hacking, greater transparency, easier auditability, cost reductions, and automation. However, this technology still faces several challenges, including legal and regulatory, as well as data privacy concerns.
The three key features of distributed ledger technology are: (i) the distributed nature of the ledger, (ii) the consensus mechanism, and (iii) cryptographic mechanisms. While these are common characteristics of a distributed ledger, the technology is continually evolving and developing, and its designs and configurations may vary widely depending on the goals and purposes of the ledger.
The distributed nature of the ledger is the technology’s most important innovation, meaning no single entity can amend past data entries and no single entity can approve new entries. The consensus mechanism (discussed below) is instead used to validate new entries and all ledger entries are propagated to each node. The removal of a single, central party can increase speeds and potentially remove costs and other inefficiencies while also enhancing security since there is no single point of attack on the ledger.
The consensus mechanism is the method by which the various nodes on the network validate new entries. The specifics of this mechanism will vary depending on the nature and purpose of the ledger but generally, this mechanism requires the network to reach a consensus regarding the validity of new entries by following a pre-defined cryptographic validation method. Bitcoin, for example, uses “proof of work” to establish consensus. Under this methodology, in order to add a new set of entries to the ledger, a difficult and arbitrary mathematical puzzle prevents anyone from gaming the system, while also ensuring that all new data is verified before being added to the ledger.
The new data being added to the ledger is “hashed,” which means a cryptographic hash function is applied to the data and computes an individualized digital fingerprint for the data. Since the hash would be different if any of the underlying data were different, it provides security from anyone attempting to tamper with it.
While there are challenges with respect to the widespread use of distributed ledger technology, there are tremendous opportunities and potential for using it to transform the way we view and administer contracts.
