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Simple and clearly stated expert opinions on blockchain technology and its financial applications

Blockchain Basics

Financial Applications of Blockchain

Blockchain Basics

What is Blockchain?

Blockchain is the name of the technology that enables an open ledger which holds the database of all transactions executed and shared across a distributed network of computers. It is also called distributed ledger technology. What brings this technology together is an intelligent combination of computer science (cryptology), economy and law, three fields that haven’t been used for a common objective before.

Blockchain is a decentralized data ledger which works similar to traditional ledgers, holding a record of who owns what. The major difference is that there is no central party verifying the transactions and keeping the main copy of the ledger.

The influx of creative developers, entrepreneurs, and investors in the blockchain ecosystem has led to the rapid growth of new applications for blockchain technology.

Four key features of blockchain are;

1. Decentralized Ledger:

There is no single point of authority, every participant in the network keeps a copy of all transactions. Transactions are secured by encryption to prevent tampering

2. Consensus Mechanism

In a blockchain protocol, the consensus mechanism dictates the conditions that nodes and validators in the network have to meet to add new blocks to the blockchain, helping keep the network secure

a. Token

In every blockchain network, the native token serves as both the unit of account and the medium of exchange. Transactions on the network are priced in terms of the token, and the entire system is typically denominated in its own native currency.

b. Smart Contracts

Transactions can be sent with rules-attached programs that govern when and how transactions are processed.

How Does Blockchain Work?

Video by Institute for the Future (IFTF), 2016

A blockchain is a tamper-evident, shared digital ledger that records transactions in a public or private peer-to-peer network. Distributed to all member nodes in the network, the ledger permanently records, in a sequential chain of cryptographic hash-linked blocks, the history of asset exchanges that take place between the peers in the network.

All the confirmed and validated transaction blocks are linked and chained from the beginning of the chain to the most current block. The blockchain thus acts as a single source of truth, and members in a blockchain network can view only those transactions that are relevant to them.

Instead of relying on a third party, such as a financial institution, to mediate transactions, member nodes in a blockchain network use a consensus protocol to agree on ledger content, and cryptographic hashes and digital signatures to ensure the integrity of transactions.

Consensus ensures that the shared ledgers are exact copies, and lowers the risk of fraudulent transactions, because tampering would have to occur across many places at exactly the same time. Cryptographic hashes, ensure that any alteration to transaction input — even the most minuscule change — results in a different hash value being computed, which indicates potentially compromised transaction input. Digital signatures ensure that transactions originated from senders and not imposters.

The decentralized peer-to-peer blockchain network prevents any single participant or group of participants from controlling the underlying infrastructure or undermining the entire system. Participants in the network are all equal, adhering to the same protocols. They can be individuals, state actors, organizations, or a combination of all these types of participants. At its core, the system records the chronological order of transactions with all nodes agreeing to the validity of transactions using the chosen consensus model. As a result, transactions cannot be altered or reversed, unless the change is agreed to by all members in the network in a subsequent transaction.

Applications of Blockchain

Blockchain has the potential to find applications not only in banking but in wide range of areas and automate labour-intensive processes. Some of the major industries that would be transformed by blockchain are;

Financial Services – Blockchain offers a variety of applications to financial services outside the banking such as insurance and accounting. Having standardized and real-time view of transaction data without needing multiple reconciliations would remove many of the inefficiencies and reduce costs. The distributed ledger on the blockchain can make auditing transparent and enable regulators to scrutinize actions more easily.

Governments – Blockchains could be used to address inefficiencies in current government systems, reduce corruption, fraud and errors. A blockchain could serve as the official registry of physical properties owned by citizens such as houses and vehicles along with intellectual properties like patents. It could also be used to ensure that each person votes only once during an election. Marriage and birth certificates, passport issuance and taxes are some of the other areas of application.

Healthcare – Most hospitals have a hard time securing data storage and they are frequently subject to cyber-attacks. Implementing blockchain technology to store and share data with patients, other medical institutions and authorized healthcare professionals in a secure and private way not only helps to allow faster and more accurate diagnoses but to detect any abuses on the patient’s or medical system’s front.

Law – Smart contracts could eliminate the legal firms as the occurrence of certain actions are conditional on pre-defined requirements being met. When used for authentication and certification, blockchain secures the privacy of the documents and eliminates the high fees.

Energy – Smart meters can register spent electricity in a blockchain and allow consumers to use the surplus energy in a different location. In case of solar energy, the excess amount produced could be forfeited to a different customer.

Real Estate – On blockchain, anyone can manage, track, and transfer property deeds and land titles without real estate agents, avoiding high commissions, copious amounts of paperwork and long processes.

Supply Chain Management – Blockchain registers all the details pertaining to a supply chain such as involved parties, price, date, location, quality or state of a product. The public availability of the ledger would make it possible to trace back every product to the very origin of the raw material used. The decentralized ledger would make it impossible for a single party to hold ownership of the ledger and manipulate the data to their own advantage.

Blockchain Glossary

Blockchain – The technology which enables to create a distributed ledger that records stores and entails the history of all transactions.
Blockchain Genesis Block – A genesis block is the first block of a block chain. It is also known as Block Zero or Block 0. It is the only block in the Blockchain network that doesn’t refer to previous block because there isn’t any.
Distributed ledger – A digital record of ownership with no central administration. The ledger is replicated among all computers connected to the network.
Consensus mechanism – A method of authenticating and validating a value or a transaction on a Blockchain without the need to trust on a central authority. Most widely used “consensus mechanisms” are Proof of Work, which requires miners to solve cryptographic problems and Proof of Stake, where members of the network who own a certain amount of coins are allowed to verify blocks.
Hash or Hashing – A mathematical process used in cryptography that converts a amount of text or data into a numerical output.
IPFS Technology – Interplanetary File System. IPFS is a protocol and network designed to create a content addressable peer to peer method of storing and sharing hypermedia in a distributed file system.
Miners – The users that run specific software that allows them to validate, clear and record transactions on the Blockchain
Node – A computer connected to the blockchain network. Each user active on the network is a node.
Oracle – An oracle, in the context of blockchain and smart contracts, is an agent that finds and verifies real World occurrences and submits this information to a blockchain to be used by smart contracts. In other words – an oracle is a data feed provided by third party service designed for use in smart contracts on the blockchain.
Peer-to-Peer (P2P) – Interactions that happen between at least two parties in an interconnected network.
Private & Public Keys – Alphanumeric strings kept by the users designed to sign a digital communication.
Proof of Concept – Exercise to test the design idea of assumption
Proof of Work – A system that requires a feasible amount of effort in order to deter malicious uses of computing power. Nodes compete to agree which block is real by solving mathematical problems, making it computationally expensive to cheat
Proof of Stake – States that a person can mine or validate block transactions according to how many coins they hold. Where nodes risk their own capital to agree consensus. If the block is not agreed the stake is lost, making it financially expensive to cheat
Tokenization – Digital Proof of ownership
Difference between tokens & digital currencies – Tokens are built and hosted on existing blockchain while coins are unique digital currencies based on their own
- A digital coin is an asset that has its own blockchain (bitcoin, ether, etc). Tokens are created on top of existing blockchains. Their purpose depends on the application itself.
- Coins may have added functionality but they are generally considered as a means of payment. Tokens have a wider functionality.