An overview of distributed ledgers and some benefits and risks of using them.
By Katherine West
Distributed ledger technology, sometimes referred to as DLT, is a relatively new technology that is quickly becoming a hot topic due to its association with cryptocurrencies like Bitcoin. But what exactly is it? Though often associated with cryptocurrencies, DLT is, at its core, a new form of record keeping that can be applied in a wide variety of settings.
According to a recent article on the website Towards Data Science, a distributed ledger is a record that is stored on a network composed of multiple computers, sometimes called nodes, members or participants. When a change to the record is proposed, each of the nodes on the network reviews the record and the proposed change, and the nodes then reach a consensus as to whether the change is valid. IBM DeveloperWorks states that distributed ledgers are unique because there is no central authority that reviews or regulates changes to the ledger. Instead, each proposed change is independently reviewed by the individual nodes on the network and, if the nodes reach a consensus that the proposed change is valid, “the distributed ledger updates itself and the latest, agreed-upon version of the ledger is saved on each node separately,” as described on the website.
Though blockchain and distributed ledger are often used interchangeably, blockchain is technically one of several types of distributed ledger. Blockchain’s defining feature is its structure. According to IBM DeveloperWorks, in addition to being stored on multiple nodes that must verify any change to the record, a blockchain distributed ledger “permanently records, in a sequential chain of cryptographic hash-linked blocks, the history of asset exchanges” that occur on the record. The verified transaction blocks “are linked and chained from the beginning of the chain to the most current block, hence the name blockchain.”
Thus, according to Towards Data Science, blockchain has an “append-only structure” that means data can only be added to the chain. Towards Data Science further explains that blockchain’s structure theoretically makes “altering or deleting previously entered data on earlier blocks … impossible.” Not all distributed ledgers utilize this block and/or append-only structure.
As DLT develops, so do the number of variations and uses for the technology. As noted in recent articles on BlockchainHub and Ethereum Blog, while there are not hard classification rules, there are three general privacy “levels” of DLT: public, federated (a.k.a., consortium) and private. BlockchainHub continues to explain that a public distributed ledger is fully decentralized in that anyone can access, read and participate in the transaction and verification processes of the ledger, all without obtaining permission to participate. A consortium or federated distributed ledger, on the other hand, is considered partially decentralized because there are restrictions on who can participate in the transaction and verification processes of the ledger, according to BlockchainHub.
Articles on the same sites further explain that on a federated distributed ledger, “the consensus process is controlled by a pre-selected set of nodes.” Private distributed ledgers go even further, restricting the ability to participate in transactions and verifications on the ledger to one organization. Nonetheless, according to Ethereum Blog and BlockchainHub, the right to read a federated or private distributed ledger may be public or restricted.
Each formulation of distributed ledger comes with a unique combination of benefits and risks. Some of the benefits of DLT are its immutability, security and decentralization. For example, as IBM DeveloperWorks explains, instead of hacking into a centralized network and simply changing a record on a ledger, someone hacking into a distributed ledger would need to force a sufficient number of nodes on the network to recognize the hacker’s changes as valid in order for the nodes to reach the requisite consensus that would allow the record to be changed.
On a blockchain-style distributed ledger, which is designed to only allow new information to be added, altering existing records becomes even more difficult, says Blockchain Unleashed: IBM Blockchain Blog. Similarly, as observed by CoinDesk, IBM DeveloperWorks, and Ethereum Blog, the decentralized nature of a distributed ledger, especially a public distributed ledger, can prevent administrators from altering information and, thereby, enhance trust in the accuracy of the record maintained on the ledger. Though difficult, it is still possible that a hacker could access the distributed ledger and attempt to make changes. If a hacker were successful in altering a distributed ledger, the decentralized and anonymous (or pseudonymous) nature of the distributed ledger may make it more time consuming and difficult, or even impossible, to identify the hacker. The decentralized and anonymous nature of a distributed ledger may also make it more difficult to recognize and identify participants with less-than-honorable intentions.
Some additional costs and risks associated with DLT include creating and maintaining a distributed ledger, environmental impacts and legal and regulatory uncertainties. While there are numerous varieties of distributed ledgers and some companies have begun offering distributed ledger-style services, articles on CoinDesk and TradeIX reveal that the costs of creating and maintaining a distributed ledger are not always clear, especially when it comes to creating a federated or private distributed ledger. There are also environmental costs associated with distributed ledgers, such as the energy costs of mining cryptocurrency, as discussed by InsideEcology, Phys.Org and Investopedia. Finally, there are still numerous legal and regulatory uncertainties surrounding distributed ledgers that could affect their usefulness going forward.
DLT is still in the early stages of development and there are certainly issues that will need to be resolved as reliance on DLT grows. Increased use of DLT may also reveal additional benefits and issues that have not yet been considered. Nonetheless, the potential applications of DLT appear vast, if not limitless. DLT is, therefore, something everyone should be watching.
Katherine West is an associate in Burr & Forman’s Birmingham, Ala., office where she practices in the financial services litigation group. For more information, visit www.burr.com.