Emmanuel Vassor is a research assistant in American Foreign Policy at SAIS Johns Hopkins and a consultant at the World Bank. He received a MSc in Business Strategy from Edhec Business School in 2012 and an MA in International Relations and International Economics from SAIS Johns Hopkins in 2018. From 2012 to 2016, he worked with Latin American government agencies on biometric and digital identity programs for a global technology company. He can read Russian, chat in Italian and fluently speak French, Spanish, English, and Portuguese.
This article is the first in a two-part series. The first part serves as a policy primer; the second analyzes governmental applications of blockchain through case studies of early adoption.
The views and opinions expressed in this article are the author’s own and do not necessarily reflect the official policy or position of the World Bank.
Introduction
Blockchain has swept contemporary discourse, from tech circles to governments worldwide. We read every day about the formidable potential of this new technology, demonstrated in examples ranging from the United Nations World Food Programme’s “Blockchain Against Hunger” program in refugee camps in Jordan, to the World Identity Network’s advocacy for adoption of self-sovereign identity based on Blockchain to combat human trafficking, to startup Follow My Vote’s initiative to increase transparency and guard against fraud in U.S. elections.[1][2][3] But many presentations of blockchain often either oversimplify what it actually is or aim at highly technical audiences, limiting accessibility to most readers. Although blockchain is a complex technology, policymakers must clearly understand the primary features of blockchain and its particular jargon. Because it is designed to manage assets (financial, legal, property), blockchain will also require significant legal regulation in the near future. Basic historical and technical understanding are prerequisites for informed consideration of blockchain’s implications, as well as for bringing its potential to bear in new domains. Providing that understanding is the purpose of this paper.
Tracing Blockchain’s Origins
The concept of a “chain of blocks” first appeared in Satoshi Nakamoto’s 2008 white paper, “Bitcoin: A Peer-to-Peer Electronic Cash System.”[4] It was presented as the technological backbone of the Bitcoin cryptocurrency. The technology seeks to enable peer-to-peer exchange of electronic cash and avoid the double-spending problem, i.e. the potential flaw in a digital cash scheme in which the same single digital token can be spent more than once, without the need for a central authority (a bank, for instance).[5] In the white paper, Nakamoto proposes to timestamp transactions, validate and encrypt them into a block using a large amount of computing power (the mining process), and then move the block into a chain forming an immutable chronological record that is shared among all the participants in the network.[6] The technology guarantees that all transactions are legitimate and that all participants have access to an identical ledger which is distributed among all participants (the nodes of the network). Because the ledger is both encrypted and distributed, it is extremely difficult to alter. Altering the ledger would require simultaneously amending the ledgers in all the nodes of the networks. The huge processing power and associated costs this necessitates and the fact any such change would be immediately detected by all the nodes in the network makes the technology extremely reliable.
Clarifying Core Concepts
A common misconception is that “cryptocurrency,” “Bitcoin,” ”blockchain,” and “distributed ledger” are interchangeable terms. They are not. In general, cryptocurrencies (of which Bitcoin is one) rely on the blockchain to create an immutable ledger of transactions which is distributed to all the nodes of a network. This is an example of distributed ledger technology, as it aims to manage reliable data in a non-centralized way.
Specifically, a cryptocurrency is a digital asset designed to work as a medium of exchange and that uses cryptography to secure its transactions, control the creation of additional units, and verify transfer of assets.[7] Bitcoin is the first and most well-known cryptocurrency to emerge, but it is just one among many different cryptocurrencies. There are now over one thousand different cryptocurrencies. Bitcoin, XRP, and Ethereum represent over 74% of the 168 billion USD total market capitalization as of December 2018.[8] As opposed to a central banking system or centralized electronic money, cryptocurrencies employ decentralized methods to establish and maintain users’ trust. The decentralized control of each cryptocurrency works through a blockchain.
A blockchain is simply an algorithm that enables digital transactions to be securely recorded in “blocks” that are linked together and chronologically added to a “chain” using cryptographic signatures to prevent any alteration. The data that is stored in the blockchain is encrypted into a unique hash, similar to a unique cyber fingerprint, and can be decrypted into readable data exclusively through the use of the respective public or private keys. The blockchain, serving as a secure and chronological record of transactions, is certainly the most promising technology underlying distributed ledger technologies.
A distributed ledger is “an asset database that can be shared across a network (of multiple sites, computers, geographies, or institutions) whose participants can have their own identical copy of the ledger, any changes to the ledger being reflected in all copies in minutes, or in some cases, seconds.”[9]
Distributed ledger technologies (DLTs) thus refer to the broad category of technologies that aim at “organizing information and transactions for asset transfers in a peer-to-peer manner” and in distributed ledgers.[10] The blockchain is a specific DLT, one which leverages cryptography in the creation and verification of data then organized in distributed ledgers.[11]
Stringing It Together: “Decentralized Consensus”
Each blockchain is governed by a particular set of rules enshrined in their backbone code and algorithm; they are often referred to as a “protocol.” The incorporation of a new block into the blockchain depends on the unique rules of the given algorithm.
Incorporation of new blocks is always, however, based on the principle of “decentralized consensus” among all participants in the network. The consensus mechanism is necessary to establish a particular transaction as legitimate, and does so by using a predefined cryptographic validation method designated for the particular DLT.[12]
For example, the Bitcoin blockchain uses the “proof-of-work” protocol to establish consensus and add new information to the ledger. The proof-of-work protocol is a “computational challenge that is hard to solve (in terms of computing power and processing time) but easy to verify.”[13] Essentially, it is a requirement for computer labor than all other users can verify, and which is difficult enough to secure to maintain slow and stable supply growth: “Any single node in the network only has a diminutively small chance of generating the required proof-of-work without expending a vast amount of costly computing resources.”[14] The Bitcoin system is calibrated such that a valid proof-of-work is produced around every 10 minutes. The process of generating proof-of-work is called “mining,” and each “miner” that produces a valid proof-of-work in the Bitcoin network receives a certain amount of Bitcoin as a reward, which serves as an economic incentive to maintain system integrity. Creating decentralized consensus is the cornerstone of DLTs and the real innovation that emerged with Bitcoin.[15]
Differentiating DLTs
There are various types of DLTs, based on the rules that govern how to participate in the network and access the distributed ledger. Indeed, distributed ledgers can be permissionless (open) or permissioned. Cryptocurrencies such as Bitcoin and Ethereum are the most well-known examples of completely open and permissionless distributed ledgers. Network participants need no permission to join or leave the network, as there is no central authority and all participants receive an identical copy of the ledger. Participants only need computers with the relevant software to join the network and add transactions to the ledger in compliance with the underlying consensus protocol. Conversely, in permissioned distributed ledgers, participants are pre-selected by an identified network administrator who controls network access and sets the rule of the ledger. Such permissioned ledgers address most of the concerns governments and regulators have with open distributed ledgers, e.g. identity verification of participants, network governance, and ownership of the ledger. Its main disadvantage, however, is that it requires a central authority that is trusted by all participants. Because there is a central authority, the need for a power-intensive process to validate transactions is greatly reduced.
Permissioned distributed ledgers are the technologies that most interest governments and businesses, as these technologies allow them to maintain a form of control over the system while benefiting from most of the advantages of DLTs. As the World Bank notes, “In reality, this is not a binary categorization [permissioned vs permissionless or public vs. private] as the degree of openness and decentralization of distributed ledger systems falls on a spectrum.”[16] To understand this, we can distinguish distributed ledgers based on whether they are public or private in terms of access to the information, and permissioned or unpermissioned (open) in terms of roles and capability to add data. The most adequate design still depends on the distributed ledger´s objectives and on the scope of the network.
The Three Major Advantages of Distributed Ledgers
Though generalizations are difficult given the large spectrum of possible designs, DLTs based on a blockchain have three potential advantages over centralized ledgers as they combine the features of both the blockchain and distributed ledgers.[17] First, as we have discussed, because ledgers are distributed among all participants in the network and every transaction is verified cryptographically and updated immediately across all the nodes, there is not a single point of failure and the system is more resistant to hacking.[18]
Second, ledgers are irreversible and immutable. Blocks can only be added to the chain. All encrypted transactions include information about time, date, and participant, as well as an encryption that links it to the previous block. Any attempt to modify one block would require modification of the entire chain of blocks. Any invalid transaction is immediately identified and rejected by the consensus-based system. There can be no editing after the fact. All transactions are thus immutable and shared among all the parties in the network which provides the participants with a trusted auditable trail of all recorded transactions.
Third, transactions are verified and settled in minutes each time a new block is added to the chain. Participants interact without any third-party intermediary, which greatly speeds up the processing of transactions and enables near real-time mechanisms for the transfer of values. Enhancing speed and eliminating the intermediary can significantly reduce the cost of transactions. (Think of securely selling your house property title without the need for a notary.) In addition, “it is possible to include code that can test for specific conditions to be met and act accordingly. This enables “if X, then Y” actions to be built into the transaction in the form of smart contracts that foster automation and enforcement.”[19] This can significantly reduce transaction costs and, consequently, lower the barrier to transaction while enabling “automated transaction execution upon satisfaction of agreed-upon conditions between parties to the ledger,”[20] all while guaranteeing the security and the immutability of the ledger.
Concluding Remarks
While often confused in mainstream discourse, blockchain and the distributed ledger technologies it facilitates have the capacity to fundamentally transform how transactions are processed and stored. These new technologies create immutable and secure transaction records that can significantly improve auditability, security, and transparency. By generating decentralized trust between participants and enabling disintermediation between parties, they also enable more efficient and cost-effective transactions. In sum, they can enhance transactional records transparency by sharing a unique and reliable version of a valid ledger to all the interested stakeholders. This prevents asset misappropriation and corruption, promotes efficiency by enabling quick and secure sharing of assets between stakeholders, and security by better protecting critical data infrastructures.
Blockchain offers the prospect of groundbreaking improvements in all areas of information and asset management – but only if properly understood. In the second part of this feature, we explore ways in which government, in particular, stands to benefit from informed and inspired uses of blockchain.
Footnotes
[1] World Food Programme, “Blockchain Against Hunger: Harnessing Technology In Support of Syrian Refugees,” May 30, 2017, https://www.wfp.org/news/news-release/blockchain-against-hunger-harnessing-technology-support-syrian-refugees.
[2] World Identity Network, “Pursuing Innovative Approaches for Access to Personal Identity,” last accessed December 21, 2018, https://win.systems/about-win/.
[3] Nicolas Guillermo, “How We Can Stop All Voter Fraud,” August 31, 2016, https://followmyvote.com/how-we-can-stop-all-voter-fraud/.
[4] Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System,” Bitcoin.org, October 31, 2008, https://bitcoin.org/bitcoin.pdf.
[5] The double-spend problem is well illustrated by the following example given by Don Tapscott: “If I send you an MP3 file and I send it to somebody else, it’s a problem for the record industry, but it’s not a massive problem. If I send you $20, and I send the same file to somebody else, that’s a big problem. It’s called fraud, and the economy stops if you have a monetary system based on that. What happens is, I send you the $20, and these miners, to make a long story short, go about authenticating that the transaction occurred.” McKinsey&Company, “How blockchains could change the world“ (interview with Don Tapscott), May 2016, https://www.mckinsey.com/industries/high-tech/our-insights/how-blockchains-could-change-the-world.
[6] Nakamoto, “Bitcoin.”
[7] See, for example, Andy Greenberg, “Crypto Currency,” Forbes, April 20, 2011, https://www.forbes.com/forbes/2011/0509/technology-psilocybin-bitcoins-gavin-andresen-crypto-currency.html#1fc46dcd353e.
[8] Respectively, 53% for Bitcoin, 11% for XRP and 9% for Ethereum. For current market capitalizations see “Top 100 Cryptocurrencies by Market Capitalization,” CoinMarketCap, last accessed January 2, 2019, https://coinmarketcap.com.
[9] Sir Mark Walpot et al., “Distributed Ledger Technology: beyond block chain,” UK Government Office for Science, January 19, 2016, https://www.gov.uk/government/news/distributed-ledger-technology-beyond-block-chain.
[10] Harish Natarajan, Solvej Karla Krause, and Helen Luskin Gradstein, “Distributed ledger technology (DLT) and Blockchain,” World Bank Group, December 1, 2017, http://documents.worldbank.org/curated/en/177911513714062215/pdf/122140-WP-PUBLIC-Distributed-Ledger-Technology-and-Blockchain-Fintech-Notes.pdf.
[11] Ibid.
[12] Ibid.
[13] Ibid.
[14] Ibid.
[15] Recorded assets can be not only cryptocurrencies, but also financial, legal, physical, or electronic. With DLT algorithms, collaborative distributed ledgers now have properties and capabilities that go far beyond traditional ledgers.
[16] Ibid.
[17] Jason Killmeyer, Mark White, and Bruce Chew, “Will blockchain transform the public sector?” Deloitte Center for Government Insights, Deloitte University Press, 2017, https://www2.deloitte.com/content/dam/insights/us/articles/4185_blockchain-public-sector/DUP_will-blockchain-transform-public-sector.pdf.
[18] The security comes from the extraordinary amount of processing power that would be required to simultaneously hack all the many nodes of the network, as opposed to the few sites in which ledgers are stored in centralized systems.
[19] Ibid.
[20] Ibid.
